Ray Dalio Is Kinda, Sorta, Really Wrong, Part 3

By John Mauldin

Source: Tax Foundation

Source: Bloomberg

Source: Bloomberg

Source: Tax Foundation

Source: Investopedia

Deeper in the red

As growth slows, the spectre of local-government debt looms once more

The central government urges spending, but regions are burdened by debt




A STATUE OF a golden bull, poised to charge, stands outside the headquarters of Xiangtan Jiuhua, a government-owned company that funds much of Xiangtan’s infrastructure investment. It has seen better days: the gold paint is flaking and the torso is cracked. That makes it a fitting symbol for public finances in the sprawling prefecture of 3m people in central China, and scores of similar cities across the country, where the ambitions of local officials have collided with heavy debt loads.

Concerns about local balance-sheets in China have recurred over the past decade. Recently they have come into sharp focus again. Attempts to clean up local debts have not worked. And borrowing looks set to rise as the trade war rumbles on: China wants its provinces and cities to prop up growth by building roads and railways.

At just 38% of GDP, less than half the average in advanced economies, government debt in China might seem under control. But that misses much of what is happening. Local governments have long relied on off-balance-sheet debt to solve a perennial policy quandary.

They are responsible for about 85% of public expenditures, yet command only 50% of revenues. Moreover, central authorities make it hard for them to borrow formally, hoping to limit their profligacy. So they have created entities such as Xiangtan Jiuhua, referred to as “local-government financing vehicles” (LGFVs). These are registered as companies. But creditors know—or, rather, assume—that the state stands behind them.

At last count China had 11,566 LGFVs. According to the IMF, when they are factored in, government debt rises to about 70% of GDP. This is worrying for three reasons. The first is the trajectory, with LGFV debts more than tripling over the past decade. The second is their opacity. Banks and bond investors think they must be safe, but even government auditors struggle to get a full picture of what is owed and where the money is going. Third, it is China’s poorer inland provinces that are most reliant on LGFVs. China International Capital Corp (CICC), a big domestic brokerage, has referred to them as a “grey rhino”: a risk that, unlike a “black-swan” event, is obvious but easily ignored.

The government, to be fair, does not have its eyes closed. It has been trying to limit LGFV borrowing since 2010. Regulators have also sought to ease financial constraints on local governments, most notably through a giant debt swap in which local governments exchanged trillions of yuan in LGFV bonds for official bonds charging lower interest.

But big risks remain. LGFVs are becoming less able to pay back their debts. Their operating incomes cover only about 40% of their obligations due within one year, according to CICC. For a normal company, that would spell trouble. Moreover, local governments remain addicted to them. Stripping out the bond swap, LGFV borrowing rose at 20% annually over the past five years, far outpacing overall debt growth.

Last year China seemed to be getting serious about crimping off-balance-sheet borrowing. It wielded its most potent weapon: permitting defaults. On 15 occasions LGFVs failed to repay loans on schedule, according to Fitch, a ratings agency. That spooked markets. LGFVs’ interest rates went up, and their bond sales slowed.

The impact was palpable. Local governments had less cash to spend, and Xiangtan was one of the casualties. It was forced to halt work on a highway around the city, which now stops abruptly at hoardings plastered in yellowing propaganda posters. A dirt track takes the place of an on-ramp. Zhou Juzhen, a retiree, has planted a small garden of chili peppers and green beans at its edge. “I wish the construction would resume,” she says. “It would be much more convenient living next to a big road.”

The slowdown in building has played out on a national level. Infrastructure investment was just 1.6% higher in May than a year earlier, a big comedown from the previous double-digit norm.

Worried about slowing GDP growth, on June 10th the central government opened the door for provinces and cities to increase spending. It urged them to issue special bonds for big projects such as modernising power grids. Many think local governments will again turn to a familiar friend. “Faith in LGFVs is seemingly on the rise again!” exclaimed analysts with ICBC, a major Chinese bank.

But the government may find that last year’s stringent debt-control campaign has made provinces and cities more reluctant to open their wallets. Local officials know that once growth stabilises, they are likely to face pressure to deleverage again, says Houze Song of the Paulson Institute, a think-tank in Chicago. There is a more radical option: the central government could in effect fund LGFVs directly. China Development Bank, a giant state-owned lender, has started to offer long-term loans to LGFVs to replace their short-term debts. This is similar to the bond swap, but allows LGFVs to get cheaper funding without testing the market.

Yet there are obvious drawbacks. For one thing, it puts the central government on the hook for LGFV liabilities. And if the programme is rolled out nationwide, efforts to get them to operate more responsibly would come to naught. So far the government has reportedly tested swaps in a few places. Xiangtan is one, not least because the prefecture includes the birthplace of Mao Zedong. China’s leaders do not want to see defaults here, of all places.

At a river that bisects Xiangtan, giant pilings have been sunk to support a bridge. But the site has been abandoned, another victim of the local cash crunch. Fu Weijun, who works in a nearby steel mill, walks along its banks before his shift begins. It is just a matter of time before the bridge is completed, he says. “Western countries change too often. We can stick to the same path, no matter what.” That confidence might be shaken in the coming years.

The rich world is enjoying an unprecedented jobs boom

Capitalism’s critics are yet to notice




EVERYONE SAYS work is miserable. Today’s workers, if they are lucky enough to escape the gig economy and have a real job, have lost control over their lives. They are underpaid and exploited by unscrupulous bosses. And they face a precarious future, as machines threaten to make them unemployable.

There is just one problem with this bleak picture: it is at odds with reality. As we report this week, most of the rich world is enjoying a jobs boom of unprecedented scope. Not only is work plentiful, but it is also, on average, getting better. Capitalism is improving workers’ lot faster than it has in years, as tight labour markets enhance their bargaining power. The zeitgeist has lost touch with the data.


Just the job

In America the unemployment rate is only 3.6%, the lowest in half a century. Less appreciated is the abundance of jobs across most of the rich world. Two-thirds of the members of the OECD, a club of mostly rich countries, enjoy record-high employment among 15- to 64-year-olds. In Japan 77% of this group has a job, up six percentage points in six years. This year Britons will work a record 350bn hours a month. Germany is enjoying a bonanza of tax revenue following a surge in the size of its labour force. Even in France, Spain and Italy, where joblessness is still relatively high, working-age employment is close to or exceeds 2005 levels.

The rich-world jobs boom is partly cyclical—the result of a decade of economic stimulus and recovery since the great recession. But it also reflects structural shifts. Populations are becoming more educated. Websites are efficient at matching vacancies and qualified applicants.

And ever more women work. In fact women account for almost all the growth in the rich-world
employment rate since 2007. That has something to do with pro-family policies in Europe, but since 2015 the trend is found in America, too. Last, reforms to welfare programmes, both to make them less generous and to toughen eligibility tests, seem to have encouraged people to seek work.

Thanks to the jobs boom, unemployment, once the central issue of political economy, has all but disappeared from the political landscape in many countries. It has been replaced by a series of complaints about the quality and direction of work. These are less tangible and harder to judge than employment statistics. The most important are that automation is destroying opportunities and that work, though plentiful, is low-quality and precarious. “Our jobs market is being turned into a sea of insecurity,” says Jeremy Corbyn, leader of Britain’s Labour Party.

Again, reality begs to differ. In manufacturing, machines have replaced workers over a period of decades. This seems to have contributed to a pocket of persistent joblessness among American men. But across the OECD as a whole, a jobs apocalypse carried out by machines and algorithms, much feared in Silicon Valley, is nowhere to be seen. A greater share of people with only a secondary education or less is in work now than in 2000.

It is also true that middle-skilled jobs are becoming harder to find as the structure of the economy changes, and as the service sector—including the gig economy—expands. By 2026 America will have more at-home carers than secretaries, according to official projections. Yet as labour markets hollow out, more high-skilled jobs are being created than menial ones.

Meanwhile, low-end work is becoming better paid, in part because of higher minimum wages.

Across the rich world, wages below two-thirds of the national median are becoming rarer, not more common.

As for precariousness, in America traditional full-time jobs made up the same proportion of employment in 2017 as they did in 2005. The gig economy accounts for only around 1% of jobs there. In France, despite recent reforms to make labour markets more flexible, the share of new hires given permanent contracts recently hit an all-time high. The truly precarious work is found in southern European countries like Italy, and neither exploitative employers nor modern technology is to blame. The culprit is old-fashioned law that stitches up labour markets, locking out young workers in order to keep insiders in cushy jobs.

Elsewhere, the knock-on benefits of abundant work are becoming clear. As firms compete for workers rather than workers for jobs, average wage growth is rising, pushing up workers’ share of the pie—albeit not as fast as the extent of the boom might have suggested. Tight labour markets lead firms to fish for employees in neglected pools, including among ex-convicts, and to boost training amid skills shortages. American wonks fretted for years about how to shrink disability-benefit rolls. Now the hot labour market is doing it for them. Indeed, one attraction of the jobs boom is its potential to help solve social ills without governments having to do or spend very much.

Nonetheless, policymakers do have lessons to learn. Economists have again been humbled. They have consistently underestimated potential employment, leading to hesitant fiscal and monetary policy. Just as their sanguine outlook on finance in the 2000s contributed to the bust, so their mistaken pessimism about the potential for jobs growth in the 2010s has needlessly slowed the recovery.

The left needs to accept that many of the criticisms it levels at capitalism do not fit the facts.

Life at the bottom of the labour market is not joyous—far from it. However, the lot of workers is improving and entry-level jobs are a much better launch pad to something better than joblessness is. A failure to acknowledge this will lead to government intervention that is at best unnecessary and at worst jeopardises recent progress. The jobs boom seems to be partly down to welfare reforms that the likes of Mr Corbyn have vociferously opposed.

The right should acknowledge that jobs have boomed without the bonfire of regulations that typically forms its labour-market policy. In fact, labour-market rules are proliferating. And although the jury is out on whether rising minimum wages are harming some groups, such as the young, they are not doing damage that is large enough to show up in aggregate.

The jobs boom will not last for ever. Eventually, a recession will kill it off. Meanwhile, it deserves a little appreciation.

Technology platforms are losing control

The land grab for assets across media and food delivery shows their power is under threat

John Gapper




Everything Amazon does has an impact and by leading a $575m funding round for the British food delivery company Deliveroo, it hurt shares in the latter’s rivals. The deal gives Amazon a stake in both delivery and preparation through “dark kitchens” in which some Deliveroo meals are made.

It is an arresting move — who knew that a company that started by selling books online would end up as the part owner of kitchens? — but it is characteristic of Amazon’s roaming instinct. It has moved from online retailing to running warehouses, publishing books, and making films and television shows for its Prime streaming service.

More surprising is the degree to which other technology groups are following Amazon in becoming vertically integrated. Instead of sticking to the business of running platforms, they are creating their own content and buying assets to bolster themselves.

Netflix is close to a 10-year deal with Pinewood to lease studio facilities in the UK, while WeWork is raising $2.9bn for a property fund to buy offices that it will lease. Apple is spending hundreds of millions on video game development for its Arcade service, pushing Microsoft and Sony to form a tentative alliance to defend their games franchises.

Integration is also developing in the other direction, with brands trying to find a path to sell directly to consumers, rather than through retailers. Edgewell Personal Care, owner of the Wilkinson Sword and Schick men’s razor brands, this month acquired Harry’s, the razor subscription business, for $1.4bn. Investors took fright and Edgewell shares dropped to a 10-year low.

A sudden move to integrate by buying a supplier or distributor suggests vulnerability — why take the risk of doing it unless you fear being shut out? Controlling the supply chain from parts to production, marketing and distribution secures autonomy. But it also requires capital investment and is a challenge for any company to manage.

So far, technology companies have not been punished by shareholders for pursuing integration. Amazon is trusted to handle acquisitions, such as that of Whole Foods, the US supermarket chain, and Netflix’s huge investment in original production has not alienated investors. Their critics instead wonder whether they are acquiring too much power over markets.

Lina Khan, a fellow at Columbia Law School, has attacked Amazon for exploiting the gaps in US competition law, arguing that it has “marched toward monopoly by singing the tune of contemporary antitrust”. Ms Khan singles out its vertical integration, which is treated leniently by US authorities.

Amazon has expanded across its supply chain, into retailing and other services, and controls production and distribution assets, now including a stake in Deliveroo. This enables it to offer its own goods and services to Prime subscribers, as well as boosting its bargaining strength with other suppliers.

This contrasts with the original approach of platforms such as Google and Facebook, which focused on building networks while relying on others for content. Uber and Lyft have a similar strategy — creating ride services by linking drivers to customers, rather than by owning and operating taxis.

But as platforms mature, vertical integration is growing. The meal delivery industry is one example, moving from a traditional platform approach to one in which companies such as Deliveroo and UberEats run kitchens. Deliveroo is a pioneer with its Editions kitchen hubs, where meals are prepared by restaurants and caterers.

The threat is that someone else builds such facilities, limiting the power of any platform: Travis Kalanick, Uber’s co-founder, last year acquired a $150m controlling stake in the parent of CloudKitchens, which does so. Restaurants at its facilities in Los Angeles cook meals that are delivered by platforms including Uber Eats and GrubHub.

A similar battle is occurring in video games, with both Apple and Google setting up new streaming services. The ideal for these companies would be to have games developers flock to their platforms and pay them fees, but competition is such that they cannot rely on that. Apple is taking the same path as Netflix — investing in production to secure exclusive rights.

This makes technology companies more like media businesses that own distribution and content. Vertical integration was limited in the 1970s and 1980s by rules barring US television networks from controlling too much production but has grown. Mergers such as Comcast’s acquisition of NBC Universal have been approved by regulators.

The shift to integration by technology companies requires close scrutiny by competition authorities, as Ms Khan suggests. But it is also an expression of weakness — platforms that used to be able to dictate terms to providers of content and services now feel the need to secure assets, rather than risk being shut out by others.

If so, investors may be treating the land grab across retailing, media and other industries too complacently. They are accustomed to Amazon and others being able to dominate, but this burst of dealmaking tells a story of technology platforms losing control.

Looking Back at 100

Three themes have dominated the author's analysis of global affairs in his previous 99 Project Syndicate commentaries. All of them – Middle East turmoil, the rise of China, and the dissolution of the post-World War II and post-Cold War order – are certain to figure prominently in the next hundred.

Richard N. Haass




NEW YORK – This is my 100th column for Project Syndicate. It comes nearly 20 years after my first. As is the case with most milestones, it offers a good opportunity to take stock, to look back on what I have written, and to see what it says about the world over these two decades and where we may be heading.

Three themes stand out. The first is how much the Middle East consumed the world’s attention, including mine. Think about it: This is a region that is home to around 6% of the world’s people, and, despite possessing vast amounts of oil, accounts for less than 5% of global economic output. Yet it manages to account for a large share of the world’s headlines, conflicts, terrorists, and refugees.

Some blame the Middle East’s many problems on the European colonial powers. But that era is too distant from our own to explain today’s failures. After all, many former colonies elsewhere in the world are thriving.

That said, outsiders have made things worse over the past two decades, both by what they did (the US invasion of Iraq in 2003 comes to mind, as does NATO’s intervention in Libya and Russia’s in Syria) and by what they failed to do.

Here I would list US reluctance to act in Syria even after the government there defied warnings and used chemical weapons. While the intervention in Libya was misguided, once that decision was made, it was incumbent upon the United States and its European partners to mount an effort to stabilize the country following the ouster of Muammar al-Qaddafi.

Yet the lion’s share of the responsibility for the Middle East’s terrible record lies with the region’s leaders, who have largely failed to provide economic opportunity or political rights at home and who have refused to compromise in the cause of peace. Instead, what we have seen are prolonged and costly conflicts in Syria and Yemen, stagnation in Egypt, and fading prospects for any lasting settlement between Israel and the Palestinians.

The second theme that emerges from the past two decades is Asia’s emergence as the central arena of modern international relations. If Europe was the principal venue of much of twentieth-century world history, including two hot wars and one cold war, now it is Asia’s turn. The region is where one finds the bulk of the world’s population, the majority of its economic output, and increasingly its military might. It is where the major powers of this era face one another.

The good news is that for the past 20 years – in fact, since the end of the Cold War – Asia has remained stable, underpinned by America’s steadying hand and buoyed by rapid economic growth. The question now is whether stability will continue to be the rule, given China’s rise, the near-certainty that North Korea will not just retain but possibly expand its nuclear and missile capabilities, and lingering disputes over the South and East China Seas, Taiwan, and numerous islands and borders.

The third theme that runs through many of the previous 99 columns is the demise of the world that we knew. The titles of several commentaries say it all: “Liberal World Order, R.I.P.,” “Cold War II,” “Europe in Disarray,” “The Era of Disorder.”

One reason for this downbeat assessment is the growing prominence of a China that remains illiberal at home, engages in myriad unfair practices that boost its trading position, and is mostly unwilling to assume global responsibilities commensurate with its strength. Another is President Vladimir Putin’s Russia, which seeks to violate sovereignty – the most basic norm of what international order there is – with traditional and digital armies alike. Moreover, the gap between global challenges, such as climate change, and the willingness of the world to deal with them has widened. The thesis of my 2013 commentary, “What International Community?” still holds: the phrase stands for a concept that is more aspiration than reality.

One factor stands out amidst this deterioration: the refusal of the United States to continue to play its traditional role in the world. The last two decades have made clear that no post-Cold War US foreign policy consensus exists. What exists is wariness born of costly military interventions in Iraq and Afghanistan, and a populist surge fueled by the 2008 global financial crisis, growing inequality, and reduced upward mobility.

This is the context that gave rise to the election of President Donald Trump. Over the past two-plus years, Trump has added to global turbulence through his own unique mix of hostility to multilateral institutions and alliances; sustained use of tariffs and sanctions on behalf of goals that are so ambitious as to be unrealistic; increased military spending but decreased military action; a much-reduced emphasis on promoting democracy and human rights, coupled with a penchant for strongmen; and a faith in his own personal diplomacy but not in professional diplomats.

As suggested above, all this has contributed to the fading of the post-World War II, post-Cold War world. What will take its place is unclear; Trump is much more a disrupter than he is a builder. The next 20 years thus promise to be even more disorderly than the last 20. Sad to say, there will be more than enough material for at least a hundred more commentaries.


Richard N. Haass, President of the Council on Foreign Relations, previously served as Director of Policy Planning for the US State Department (2001-2003), and was President George W. Bush's special envoy to Northern Ireland and Coordinator for the Future of Afghanistan. He is the author of A World in Disarray: American Foreign Policy and the Crisis of the Old Order.

Finally, FOMO Arrives For Gold

by John Rubino
 

The past few years have been a feeding frenzy for most major asset classes. Stocks blew through previous highs, as did trophy real estate, fine art, and, most recently, Treasury bonds.

A big part of the reason for what came to be called the everything bubble was the sense that with everyone else making easy money, the worst possible fate was to be stuck on the sidelines, a sentiment known as “fear of missing out,” or FOMO.

Gold, alas, wasn’t invited to this party and has languished far below its 2011 high, while bouncing off resistance at the $1,360 level five (!) times over the past five years.

That may have changed this month. As central banks move back into easing mode – with interest rates already at historic lows, implying that future cuts will take even more of the world into negative territory – and the US blunders ever-closer to a major shooting war, safe haven assets are suddenly in vogue. And gold has popped.




Now the emotional tone of the precious metals market borders on giddy, with dozens of recent headlines quoting analysts on their upwardly-revised gold price targets and new buy ratings on precious metals mining stocks.

In other words, where just a few weeks ago would-be gold and silver buyers thought they had plenty of time and feared being stuck in a dead-money asset, they now feel like time is running out. FOMO has become their dominant impulse.

Here’s an excerpt from a King World News interview with Michael Oliver, a technical analyst who has been predicting a sharp, quick upward move in precious metals for the past few months and was — sharply and quickly — proven right in June. Not surprisingly, he thinks the current move has very long legs:

This is a new massive gold bull leg that’s an extension of the bull market that began in the 1970s…Most price chart analysts are looking at this and are thinking ‘I have to be in this or I’m’ going to miss it.’ We’ve rapidly taken out the highs of the past five years.  

Money managers who have not been in gold are being jolted into the sense that they have to be part of this. Especially with the gold miners, which are rising at double the rate of the metals. When these folks start to move assets into this sector it can have a dramatic effect. They’ll move explosively higher.  

Most people will be shocked where the next rest stop for the gold miners. GDX was $20 recently and could be above $30 in short order. It’s a new dynamic and all the price-related technical indicators that most people look at will be shattered to the upside. Ignore those overbought signals.  

By the end of the year we should see $1,700 in gold. That’s not the end, it’s just where it will be at year-end. We’re in a major situation.  

Silver, meanwhile, is about to slingshot to catch up with gold. It will do twice as well as gold, too quickly to allow time for committee meetings to decide whether or not to buy.  

You won’t get a measured move – expect a move from the mid $15s to over $20 in a matter of weeks. But that will be just the beginning. 

If you’re not there you’re going to miss it.

Visiting China

By George Friedman        

(click to enlarge)