Where’s the logic in holding bonds without an income?

I refuse to pay German and Japanese governments for the privilege of lending to them

John Redwood

BERLIN, GERMANY - JANUARY 16: A pin displaying the German and the Japanese national flags is pictured on January 16, 2014 in Berlin, Germany. (Photo Illustration by Thomas Trutschel/Photothek via Getty Images)

I cannot bring myself to buy sovereign bonds offering negative yields. It’s a crazy world where people will pay the German or Japanese government for the pleasure of lending to them.

Presumably investors who buy bonds offering a guaranteed loss if you hold them to redemption do so because they expect to sell them to someone who pays an even more ludicrous price well before the bond is repaid. I would find it impossible to explain why I had bought such bonds if they went wrong and sanity returned.

Time was when investors bought government bonds for income and shares mainly for capital gains. Now they buy good quality bonds for capital gains, and can pick up a decent income by buying shares. The FT fund has avoided Japanese and euro debt because it offers such a bad deal. The longer dated UK debt the fund does hold has performed more like a riskier equity in a bull market this year. Even the more cautious shorter dated UK debt the funds owns has seen buying interest push some prices higher. The bonds are in the fund to provide some stability but have done more than that.

Logic tells you that this extreme pricing of many bonds cannot last, that there is something irrational about people holding bonds with no income when the main purpose of a bond should be to pay you a bigger income than cash. History, however, tells us that markets can persevere with ultra-low interest rates and negative rates for many years if the authorities are determined to drive rates down and keep them down in a low inflationary environment — the period following Japan’s banking crash of the late 1980s being a case in point.

The world’s main central banks are fuelling this bond euphoria with their words and actions to cut interest rates and their wish to create easier conditions. The bond markets have pushed short-term interest rates higher than some longer-term interest rates, and then claimed this proves there will be a recession. Recessions usually mean higher bond prices and interest rate cuts to try to get things going again. I see no early recession in the US nor in China, and expect the euro area as a whole will scrape by without quite entering one.

The fear of recession powers the bond market and is forcing central banks to do more than they otherwise would to promote growth with easier money. Some bond market practitioners have in the past forecast more recessions than we lived through.

The curious thing is the absence so far of serious inflationary pressures in the advanced world.

When Argentina and Venezuela try their extreme policies of large budget deficits and printing more money their currencies collapse and inflation takes off, just as pre-banking crash theory tells you it should.

Since 1990 Japan has built up a huge state debt, now 250 per cent of its national income, and created vast quantities of yen to buy in around half this debt. Inflation remains stubbornly low and the currency periodically takes it in its stride. Between these two extremes lies the rest of the world.

The Fed admits it does not fully understand current conditions and has spent recent months trying to work out what is the new normal. It does not know how low unemployment can fall before there are serious inflationary pressures. It does not understand why the US economy can approach what it thinks is its capacity without serious inflationary problems emerging. It would like to know if there is a new normal interest rate to aim for. We await clarification of what will guide future rate changes, at a time when markets are insistent that the Fed must cut more to see off low or no growth.

The FT portfolio attempts to reflect the new realities. One of the pressures keeping inflation down is the digital revolution. Another is the global marketplace. The US, UK and other central banks have tried to run their policies based on the idea of national capacity, but they need to look through national supply to the global market.

If the US and UK run out of home labour, migrants appear to take the jobs. Alternatively, some work is supplied from abroad with a high labour content met from overseas-based employees. If the US or UK hit the ceiling of the domestic economy to supply any given item a foreign version arrives rather than allowing the home producer to put up prices.

In this world, the revenues of the global winners grow more quickly than the businesses they are attacking. Revenue and profit transfers from traditional models and companies to internet-based ones, forcing traditional business to adapt or die. Maybe one day the fairly rapid growth of US money will filter through to faster growth in domestic wages, as there are areas where the economy is dependent on domestic labour with the right training and it is in short supply. That will cause issues for the Fed as it strives to meet some of the expectations for lower rates.

Meanwhile, good money growth in the US and the success of US technology companies has served this fund well.

The fund is still up by 12 per cent this year despite the sell-off recently in share markets prompted by the intensification of the Trump trade war. These tensions are causing some damage to confidence and trade volumes, but more of the slowdown results from policy decisions of the Chinese, the euro and other leading central banks and governments.

Sterling now looks cheap, so I am increasing the amount of currency cover on the US holdings. The fund has not been exposed to euro area risks in recent months, where assets have been underperforming thanks to the slowdown, the structural problems of the motor industry hitting Germany, and the continuing budgetary problems in various member states.

Sir John Redwood is chief global strategist for Charles Stanley. The FT Fund is a dummy portfolio intended to demonstrate how investors can use a wide range of ETFs to gain exposure to global stock markets while keeping down the costs of investing.

China’s President Is in Trouble

Xi Jinping has failed to manage the country’s relationship with its most important trade partner.

By George Friedman


When Chinese President Xi Jinping came to power in China, he was seen as a decisive leader who could dominate Chinese institutions and guide China to a position of greatness. His enormous power was solidified with the removal of presidential term limits, while the anti-corruption purges initiated at his behest have reshaped the Communist Party.

From my point of view, however, the imposition of a dictatorship in China was a sign of concern and insecurity within the Communist Party’s Central Committee. Dictators do not usually arise to preside over success. They emerge in times of trouble, taking or being given powers that allow them to impose their will to deal decisively with a country’s problems. Why would the Central Committee allow the office of the president to change so profoundly if things were going well? “If it ain’t broke, don’t fix it,” as the saying goes. China may not have been broken yet, but it was in danger of breaking, and Xi’s appointment was a sign of weakness rather than strength.
China’s Economic Problems
A range of significant, if not yet existential, problems have emerged since Xi took office. The most important are economic. Since 2008, the Chinese economy has been struggling, and Xi’s first task was to try to stabilize it. There were many dimensions to China’s economic problems, but the core was that China was heavily dependent on exports. Many exporting countries may appear for a time to be powerful, surging into the global system with products priced to sell. The problem, however, is that they are utterly dependent on their customers and competitors to survive. In 2008, the appetite of China’s customers for exports dramatically contracted, and competitors arose who could undersell the Chinese.

Xi was bought in to deal with this problem, and he developed two strategies. The first was to increase domestic consumption. Much of China, however, is too poor to substitute for American and European demand, and attempts to finance domestic consumption led to a serious financial crisis. The second strategy was to shift from low-priced goods to high-tech items. Competing with Europe, the United States, Japan, South Korea and other well-established high-tech economies proved difficult. The weakness of China’s strategy caused the country to try to appear more powerful than it was. It launched the Belt and Road Initiative, which offered money to a host of countries for various infrastructure projects in an effort to assert itself as a global power. It has become far less significant than it was. Suspicion arose of China’s intentions, further hampering attempts to compete on high-tech projects, as the Huawei affair exemplifies.

More important, Xi was responsible for managing China’s relationship with its single-largest export customer, the United States. Under past U.S. administrations, the United States demanded that China open its economy to American goods and end currency manipulation, but previous Chinese presidents have managed to deflect such demands. The fact was, China couldn’t afford to open its economy, since its domestic market couldn’t support both Chinese production and foreign competition. And the need to maintain exports at high levels meant that China had to manage its currency in some way. Meetings with the United States were held, dinners consumed, toasts made and the Americans went home empty-handed.

Xi visited U.S. President Donald Trump soon after Trump took office and seemed to have left with the impression that prior strategies to manage the United States were sufficient. His assumption was wrong. The United States imposed tariffs to compel China to change its behavior, but China was in no position to do so. Still, the tariffs hurt China far more than reciprocal Chinese tariffs hurt the U.S. China derived 4 percent of its gross domestic product from exports to the U.S., while the U.S. derived only about 0.6 percent of its GDP from exports to China.



Xi’s Failure
The management of U.S. trade relations was Xi’s responsibility. His failure in this regard was rooted in his strategy of portraying the Chinese military as a significant threat to the United States, in order to compensate for Chinese weakness in other areas. Chinese military strength isn’t insignificant, but the Chinese vastly overstated it. They believed this would compel the U.S. to back off, but such strategies have the reverse effect on the United States. It becomes intimidated, remembering prior instances when it underestimated its opponents. The result is that the U.S. tends to overestimate its opponents and, rather than seek accommodation, moves to dramatically increase its military power over enemies that are already no match. In space, at sea and elsewhere, the U.S. military overstated the Chinese threat. China found itself in an arms race its economy could not support, struggling to launch two aircraft carriers and hype them as a change in the balance of power.

The United States responded on multiple levels. It sailed aggressively in the South China Sea to demonstrate Chinese weakness. It developed deeper cooperation with Australia and Japan and even India and Vietnam to counter Chinese influence. It engaged in intense counterintelligence operations against Chinese nationals operating in the United States and raised hurdles to Chinese tech companies selling goods worldwide.

This was undoubtedly not what Xi expected. His goal was to position China as a massive Eurasian power, and yet, he found countries like Kazakhstan rejecting Chinese investment. He lost some of the control that China had previously enjoyed and left the Chinese economy weaker than it previously had been.

Then, the Hong Kong protests erupted. Initially, the central issue was a bill that would have allowed Hong Kong residents to be extradited to the mainland. China, of course, could put down the protests by force, but it hasn’t done so because it fears what a bloodbath would do to its fraying economic relations overseas. It clearly has sufficient intelligence on the demonstrators to be able to arrest leaders and disrupt the protests. But Xi has decided to let the demonstrations burn out. This was another miscalculation. The unrest has lasted far longer than many expected, and its main focus has shifted from an extradition bill to Hong Kong autonomy in general.

Now, there are severe questions about Xi’s competence. Certainly, many of the things that are going wrong on his watch could not be controlled or start far before he took office. But he was brought in as a virtual dictator to manage the country’s problems. Now, trade relations with the U.S. are in shambles, military initiatives have generated significant counters, showcase programs like BRI have evaporated, and Hong Kong is in revolt.

It is difficult to imagine that, given his performance, Xi’s position is as secure as it appears. Xi is enormously powerful still. He controls the People’s Liberation Army and the intelligence and security services. But in the end, the source of power in China is the Central Committee of the Communist Party of China. He could pit his forces against it, but that would plunge China into chaos and leave Xi perhaps less powerful than before. I have no evidence of an anti-Xi revolt, since such evidence would not be visible. But it is inconceivable to me that within the Central Committee, which made him the most powerful leader since Deng Xiaoping, there are no factions that see Xi as a failure. China is not a democracy, but it has a power structure that created Xi. That power structure also has the ability, in my opinion, to unmake him.

For this notional faction, the goal is to reach an agreement with the U.S. on trade that is reasonably favorable to China, end the Hong Kong demonstrations, and stop following contradictory strategies like hyping up China’s military might while trying to sell high-tech equipment to countries wary of China. In other words, they want Xi to solve the country’s pressing problems and stop creating new ones through posturing and trying to make China appear to be what it isn’t: a global power.

Dictators must be focused on their country’s main issues, and from the beginning, Xi has been scattershot. In many ways, this diffusion reflects the China’s condition, with serious achievements, vast ambitions and limited resources. I do not know what Xi’s future holds, but I do wonder how it will impact China’s.

Iqbal Khan, a bold banker who took on his boss

The man regarded as the heir apparent at Credit Suisse has been embroiled in a lurid feud

Sam Jones and Stephen Morris

© Joe Cummings

It takes a certain kind of person to move in next door to their boss. Today the biggest question in Swiss banking is just what kind of person Iqbal Khan is.

Three months ago, Mr Khan, whose rapid ascent at Credit Suisse had marked him out to many as the heir apparent to chief executive Tidjane Thiam, quit his senior position at the bank. This week, details emerged of a bitter row between Mr Khan, 43, and Mr Thiam, 57, triggered by a confrontation in central Zurich between the private banking prodigy and detectives Credit Suisse had hired to monitor him after he resigned.

It was a lurid end to a spectacular dispute between two of the most powerful men in finance — one from which Mr Khan may yet emerge triumphant. On Tuesday, he is due to take up a senior position at UBS, which would make him a likely successor to Sergio Ermotti as the bank’s chief executive. Mr Ermotti is known to admire Mr Khan’s relentless ambition, prizing it over the qualities of other more rounded contemporaries. Meanwhile, UBS’s chairman, Axel Weber, has taken a dimmer view of the spectacle, according to a person who knows him.

Bruising rows between big egos are not new in the world of finance. But the suburban dimension to Mr Khan’s collision with his boss has given it a distinctive flavour. After he boldly moved into the house next door to Mr Thiam’s two years ago, the pair channelled a simmering generational workplace conflict into bickering over house improvements and blocked views. The dispute climaxed in a row at a neighbourhood cocktail party in January.

“To me, moving in next door like that, there are two signals you might be wanting to send,” says one Credit Suisse executive. “Either: ‘We get along so well I’d like to spend more time near you,’ or else: ‘I’m coming for you.’”

Yet the image of an overweening princeling is only part of the picture. Many of those who have worked with Mr Khan recognise different sides to his personality.

“He’s the kind of guy who will treat a waiter just the same as he would a chief executive,” says Dan Zilberman, head of Europe at Warburg Pincus, who has worked with Mr Khan for the past six years. “He treats everyone with respect. He’s good with people. He’s honest and he’s humble.”

With neat spectacles, sharply parted hair and a taste for discreet but heavyweight timepieces by the luxury Swiss watchmaker IWC, Mr Khan always cut a smooth figure at gatherings in Zurich. But it was his solicitous interest in others, and memory for small personal details, that marked him out on the social circuit from other hard-driving titans of high finance.

Former colleagues say it isn’t an act. He is driven by results, rather than show, several of those who have worked with him have said. He is not brash. Until his fateful move next door to Mr Thiam, he occupied a terraced house in the low-tax but also low-key canton of Schwyz. On one of his first trips to hire a new team for Credit Suisse, he flew economy class to South America.

Mr Khan’s first boss at Credit Suisse, Hans-Ulrich Meister, would regularly tell colleagues and clients that he was the best hire he ever made.

“He was very eloquent,” recalls one colleague. “He has this rare mix of being both analytical and details-driven, but also a very sharp communicator.”

Mr Khan, the son of a Pakistani father and a Swiss mother, moved to Switzerland from Karachi aged 12. He worked as an apprentice in a local accountancy firm in the small town of Dübendorf from the age of 15, studying out of hours to earn a diploma and later qualifying as a chartered accountant. In 2001, he joined Ernst & Young, becoming the youngest ever partner of the firm’s Swiss arm at the age of 31. In 2013, he moved to Credit Suisse.

When Mr Thiam joined the bank two years later, Mr Khan stood out. “Iqbal really caught his eye,” says one senior Credit Suisse executive. When he was 40, Mr Khan was promoted to lead a new international wealth management division. In the next three years he boosted earnings from SFr1bn to SFr1.8bn, according to Andreas Venditti, an analyst at Vontobel.

Every year, Mr Khan threw a party for his top-performing lieutenants at a luxurious hotel high above Lake Lucerne. Expensive wine and champagne flowed, with Mr Khan overseeing proceedings like an indulgent monarch happy to dispense praise where it was due. “It was his court,” says one guest.

In March, Mr Thiam attended the annual bash. There was a noticeable chill between the two men. The rift that opened in January had widened. If Mr Khan was happy to dole out praise to those under him, he also expected his own achievements to be recognised.

When it became clear that Credit Suisse’s chairman, Urs Rohner, would not force Mr Thiam to give Mr Khan more of the limelight, he began talking to rivals. In late spring, he took a PowerPoint presentation to the board of Julius Baer, explaining why the Swiss private bank should make him its new head.

Mr Khan was not short of other offers. But even after his resignation, Mr Thiam still saw in him a serious threat — and not without reason. The loyalty that Mr Khan commands from those who worked for him — and his reputation for getting results — made him more than just a pretender to the throne. Mr Khan had a legitimate claim.

The writers are the FT’s Switzerland and Austria correspondent and European banking correspondent

Preventing Cold War II

At its founding in the aftermath of World War II, the United Nations was conceived above all as the guardian of a rules-based multilateral order that would ensure peace. Today, the UN must play a more active guardianship role – and help prevent another costly and potentially catastrophic superpower conflict.

Kemal Derviş

dervis92_sundaemorning_getty Images_us china chess

WASHINGTON, DC – When world leaders gather in New York later this month for the annual United Nations General Assembly meetings, they will have much to discuss besides climate change and sustainable development. In particular, the escalating superpower rivalry between the United States and China poses a growing risk to the world. The UN must therefore make helping to avoid another Cold War central to its mission today.

Amid all the debate regarding the demise of multilateralism and the emergence of a G2 world dominated by America and China, it is easy to forget that a similar system – featuring the US and the Soviet Union – existed for decades after World War II. Only in the late 1970s and 1980s did it become evident that the Soviet system could not compete with market capitalism. After the fall of the Berlin Wall in 1989 and the subsequent Soviet collapse, that G2 world gave way to a G1+n order in which all other countries (n) were unable to rival America as the sole global superpower.

The ensuing quarter-century was a period of liberal rules-based multilateralism. Democratic and market-based capitalism had seemingly triumphed in what Francis Fukuyama called “the end of history.” The US broadly championed this order – the 2003 Iraq War being a clear exception – and, like most countries, benefited enormously from globalization and the emergence of new complex value chains.

But the spectacular rise of China during this period has now put an end to the G1+n order. Although America is still the world’s leading economic, technological, and military power, it increasingly must share that status with China.

Some argue that we now live in a multipolar world, in which important midsize countries have enough power to influence global affairs. On this view, while the world is not flat, it has many hubs in domains such as financial flows, trade, Big Data management, and the Internet. This hub-and-spoke structure gives rise, in turn, to many different forms of possible cooperation and competition among governments.

This model offers a plausible description of the role of countries such as India, Germany, Russia, Brazil, and Japan in today’s global system. It also highlights how power, and the opportunity to form effective coalitions for collective action, depends on the issue in question and the associated fragmentation or concentration of interests.

Yet, this multipolar view of the world underplays the huge power imbalance between the G2 and the rest. India, for example, is similar to China in terms of population, but its GDP (at market prices) is only about 20% the size of China’s. Moreover, Indian military and technological capabilities, though impressive, are nowhere near those of China or the US. The same can be said for other important midsize countries.

Such imbalances are reminiscent of the 1945-89 order. Similarly, albeit perhaps not as starkly as the US and the Soviet Union during the Cold War, America and China are divided by ideology and have mutually antagonistic relations. Yet, economically, decades of globalization have made them far more interdependent, resulting in “two systems, one world,” as former German foreign minister Joschka Fischer has put it. This interdependence has become both a strategic asset and a liability, because both sides can seek geopolitical gain by weaponizing global networks such as supply chains, financial clearing systems, and telecommunications infrastructure.

Two developments could change the current picture. First, China and the US could each evolve in a way that brings them closer together ideologically. A new US administration after the 2020 presidential election could steer a more internationalist course, while China’s remarkable economic progress may yet lead to gradual political liberalization, however unlikely such a prospect may appear today. If such movements gain traction, they could reinforce each other.

Second, a more integrated European Union could become the third superpower in a G3 world and play a key balancing role vis-à-vis the US and China. Europe has the necessary economic, financial, technological, and human resources, and multilateralism is in the EU’s DNA.

Ideally, both developments would take place simultaneously. If a more integrated Europe and an outward-looking America were to strengthen their ties and once again support multilateralism as the best way to preserve peace and deliver global public goods such as climate protection, then it would be more difficult and costly for China to stand apart.

Over the longer term, however, Chinese power is likely to rival that of the US and Europe combined. Although long-run economic forecasts must be treated with caution, the OECD’s projections for real GDP growth suggest that by 2040, China’s economy will be as large as those of the US and the EU27 together. GDP is only one metric, of course, but others relating to technology or skills yield similar results.

This year’s UN General Assembly will take place amid worrying parallels with the old Cold War. Through their escalating trade dispute, the US and China are inflicting substantial economic costs on themselves and other countries. And if the world becomes divided more sharply into “two systems,” it will be far harder to reach agreement on much-needed international regulations in areas such as taxation, cyberspace, and biogenetics.

The UN, with its specialized agencies, is more than a forum for governments; it also derives soft power from the “planetary” goals of peace and development – and now climate protection – for which it stands. At its founding in the aftermath of World War II, the UN was conceived above all as the guardian of a rules-based multilateral order that would prevent violent conflict between member states. Today, it must again pursue its founding mission and help prevent a new and different, but equally perilous, cold war.

Kemal Derviş, former Minister of Economic Affairs of Turkey and former Administrator for the United Nations Development Program (UNDP), is Senior Fellow at the Brookings Institution.

What a Real Credit Crackdown Looks Like

India is upturning its shadow-banking sector. Chinese policy makers should watch closely.

By Mike Bird

An emerging-market economy with a population of over a billion is recording its slowest growth rates in years, triggered by a crackdown on rampant nonbank lending. No, not that one.

India is demonstrating how a sharp squeeze on shadow finance— credit from outside traditional banking—can feed quickly through to an economic slowdown when the crackdown hits multiple key sectors at once. Other countries, particularly India’s large and credit-driven neighbor to the northeast, should take heed.

Indian automobile sales recorded in August their worst year-over-year fall in three decades, figures released Monday showed. Sales fell 41% compared with the same month last year, the 10th month in negative territory. Nonbank financial companies, or NBFCs, make up more than half of new-vehicle finance in some categories.

Problems with Indian shadow banking began making international news late last year with the failure of Infrastructure Leasing & Financial Services. The lender was brought low by maturity mismatches: financing long-term projects with short-term funding.

Twelve months later, following a crackdown on shadow banks’ short-term borrowing, more than 15% of the 11,402 NBFCs identified by India’s central bank in its June 2018 financial stability report have shut. Disbursements of new NBFC loans dropped by 30% in the second quarter from a year earlier, according to data compiled by the Finance Industry Development Council, an industry group representing NBFCs.

Meanwhile, regulatory curbs on another type of nonbank finance have severely damaged the property sector, where house prices are growing at close to their slowest rate in a decade.

A luxury residential project in Mumbai. Photo: Dhiraj Singh/Bloomberg News

India’s Real Estate Regulatory Authority, established three years ago, has mandated that property developers keep 70% of housing presales proceeds in an escrow account until the completion of a project. Presales are effectively an interest-free loan from a buyer, and the new regulation limits what was once a key form of nonbank funding for developers.

This all adds up to a double punch for the Indian economy. India grew an annualized 5% last quarter, the lowest rate in six years. That may sound solid, but economists think the country needs 8% growth simply to supply enough jobs for its quickly growing population.

All of this should be of particular note to the Chinese government, as the vast majority of property sales in the country are still presales. In China, lending by other financial intermediaries—shadow financiers—ran to 92.5% of gross domestic product by the end of 2017, compared with India’s 28.8%, according to the latest data from the international Financial Stability Board.

Beijing’s efforts to limit leverage have had a stop-start tendency and haven’t formally included property presales. Investors curious how a broader crackdown might feed through to the rest of the economy should have a careful look at its neighbor to the southwest.