Green light, go

Turkey launches an attack on northern Syria

The long-feared clash will have consequences across the Middle East

IT SEEMED ALMOST inevitable that America would forsake the Kurds in Syria. It took Donald Trump to do it in such haphazard fashion. On October 6th the president announced that American troops would withdraw from northernmost Syria. He then acquiesced in neighbouring Turkey’s plan to invade and rout the Kurds who control the area. Mr Trump has long wanted out of Syria, but his abrupt decision blindsided American officers, to say nothing of the Kurds. On October 9th the Turkish army began its offensive.

America has about 1,000 troops in Syria, a vestige of the campaign to defeat Islamic State (IS). America’s informal allies in that fight included a Kurdish militia known as the People’s Protection Units, or YPG. The Kurds fought bravely and effectively against the jihadists and gained control of a statelet called Rojava. That created an intolerable situation for Turkey, because the YPG has close ties with the Kurdistan Workers’ Party (PKK), a separatist group that has fought the Turkish army for 35 years. 

Around 150 American troops were thus stationed on the border to serve as a tripwire between a NATO ally (Turkey) and a reliable partner (the Kurds). Diplomats sought to mollify the Turks. A deal last year saw the YPG withdraw from Manbij, a town west of the Euphrates. In August Turkey and America agreed to set up a buffer zone down the length of the border. None of this worked. Recep Tayyip Erdogan, Turkey’s president, not only opposed America’s co-operation with the YPG, but also any Kurdish autonomy in Syria.

To head off a Turkish incursion, America had to promise the Kurds an open-ended deployment in north-east Syria. That was an untenable policy, particularly in the age of Mr Trump. He tried to withdraw all American troops from Syria in December after a phone call with Mr Erdogan. That decision (announced, naturally, on Twitter) prompted his defence secretary, James Mattis, to resign and was quickly reversed.

His announcement on October 6th was no less contentious. In a rare split with Mr Trump, Republican lawmakers joined their Democratic colleagues to condemn the move. Lindsey Graham, a Republican senator close to Mr Trump, warned of “most severe sanctions” against Turkey if it went ahead with an offensive.

Mr Trump himself was characteristically erratic. In the space of 48 hours he all but endorsed the Turkish operation, threatened Turkey with sanctions should it cross his unspecified red lines, and then praised its contribution to NATO. Turkish officials who thought they had a deal with Mr Trump were left puzzled and fuming. “We don’t see only a single US any more, but many voices coming from different interest groups,” said Mesut Hakki Casin, an adviser to Mr Erdogan.

On the ground, America’s drawdown has already begun. Its soldiers have abandoned outposts near the towns of Tel Abyad and Ras al-Ain. As the Turkish army advances, backed by local Sunni Arab rebel groups that are not terribly fond of America, it will grow ever harder to protect the American troops elsewhere in Syria. What began as a limited withdrawal may end with America abandoning all its positions.

But talk of an imminent slaughter of the Kurds is probably overblown. Despite a reputation for standing their ground, Kurdish fighters deprived of American support are unlikely to want open conflict with a larger Turkish army—especially not on the flat plains of north-east Syria. Still, an incursion could displace many of the 750,000 people living along the border.

Hunkered down on their side, the YPG will have nowhere to turn but south. The group might cut a deal with Bashar al-Assad, Syria’s dictator, relinquishing some autonomy in exchange for the regime’s protection. To the long list of unintended consequences in the Middle East, add this: Kurdish fighters trained by America could end up pressed into service for Mr Assad.

Apart from Turkey’s own Kurds, plus some liberals, most Turks are likely to cheer the coming offensive. The main opposition parties make a habit of deferring to Mr Erdogan whenever he invokes national security. He suffered a setback earlier this year when his Justice and Development (AK) party lost control of Turkey’s biggest cities in local elections. Success in Syria could offset the damage.

Most Turks are also likely to back Mr Erdogan’s plan to flood the areas now under Kurdish control with some of the 3.6m Syrian refugees living in Turkey. Opinion polls show mounting levels of resentment towards the guests. Since the start of the year, Turkey has sent thousands of them back to Syria. Mr Erdogan says the 30km “peace corridor” his army plans to create would be a magnet for up to 2m refugees. This is either delusional or a euphemism for forced resettlement. Sending mostly Arab refugees to a region populated mostly by Kurds risks fanning tensions and future conflict.

According to Mr Trump, Turkey has promised to take responsibility for tens of thousands of IS fighters and their families now held in north-east Syria. Most are under YPG guard in camps like Al-Hol, home to some 70,000 people who live in increasingly desperate and unsafe conditions. But Mr Erdogan’s proposed safe zone does not include Al-Hol. And Turkey does not have a good track record when it comes to jihadists. Many first reached Syria by taking advantage of lax Turkish border controls. With the YPG distracted by enemies to the north, American officers fear IS will have space to regroup.

America never had a coherent Syrian policy. Barack Obama called for Mr Assad to go, yet refused to help rebels get rid of him. He declared the use of chemical weapons a “red line”, then failed to enforce it. His choice of the Kurds to fight IS was expedient but put America at odds with Turkey. Mr Trump has accelerated an inevitable conflict. He does not seem to have thought about what comes next.

Why the index fund ‘bubble’ should be applauded

High profits of active managers are unlikely to survive the rise of passive funds

Robin Wigglesworth

This photo provided by Paramount Pictures shows, Jeremy Strong, from left, as Vinny Peters, Rafe Spall as Danny Moses, Hamish Linklater as Porter Collins, Steve Carell as Mark Baum, Jeffry Griffin as Chris and Ryan Gosling as Jared Vennett, in the film,
The Big Short. The doctor-turned-money manager Michael Burry — one of the heroes of the film — recently caused a stir by arguing that index funds are a massive bubble © AP

Thanks to Hollywood, the protagonists of Michael Lewis’s The Big Short enjoy mainstream fame that most financiers can only dream of. But celebrity and clairvoyance are rarely positively correlated.

The iconoclastic doctor-turned-money manager Michael Burry — one of the heroes of The Big Short, portrayed by Christian Bale in the subsequent film — recently caused a stir by arguing that index funds are a massive bubble. He even likened them to the toxic collateralised debt instruments that he shorted ahead of the financial crisis.

The index fund universe has certainly ballooned, and now holds close to $10tn, according to the Investment Company Institute. That is still just a fraction of the global asset management industry, but is up fivefold since before the financial crisis.

The shift is particularly stark in the US, the birthplace of the index fund some 40 years ago. Morningstar estimates that as of last month passive funds in the US manage more money than the “active” stockpickers that have reigned since the advent of the mutual fund. An arbitrary milestone, but a notable one nonetheless.

Setting aside the fact that “bubble” is a grossly overused term, this could more accurately be described as the overdue deflation of an active management bubble, which has expanded for nearly a century despite reams of evidence that most money managers underperform the market after fees.

Last week S&P Global released the results of institutional fund manager performance for 2018, and it wasn’t meaningfully better than the results it has compiled for mutual funds aimed at retail investors. Even before fees have been deducted, almost 78 per cent of big equity mutual fund managers and 73 per cent of institutional accounts have underperformed the S&P 500 over the past decade. To varying degrees, the same is true of other regions and other asset classes.

The late Jack Bogle, founder of Vanguard, liked to call this the iron law of asset management: the average investor cannot sustainably outperform the broader market, and after fees is doomed to lose money, so the imperative must be to keep costs at a minimum. That reality is now belatedly sinking in, naturally leading to an irresistible, tectonic shift of money from traditional strategies to cheaper index-mimicking ones that is still in its infancy.

Fees have come under intense pressure in recent years, but remain high. The listed US asset management industry still enjoys a profit margin of more than 22 per cent — twice the S&P 500 average. That means there is plenty of room for prices to slide further. Index funds are pretty much the embodiment of Jeff Bezos’s famous quip that “your margin is my opportunity”.

No wonder then that Cyrus Taraporevala, the head of State Street Global Advisors, joked at the FT’s Future of Asset Management conference last week that the industry seemingly faced a crossroads between “one path leading to despair and utter hopelessness, the other to total extinction”.

Dr Burry’s argument that index funds make the equity market less efficient is not borne out by the evidence. In fact, it seems that on a broad perspective it is having the opposite impact.

By driving out poor and mediocre fund managers that in reality do little but charge expensive fees to hug their benchmark, markets become more efficient. The best analogy is a poker game where the poorer players lose their money and drop out first. That makes the game harder for the more skilled players that remain, not easier.

There are real questions about the instant liquidity promised by exchange traded funds and the underlying liquidity of some of their securities, especially at a time when trading conditions of many markets seem to have deteriorated. Yet there have been several major tests of the mechanics of ETFs in recent years, without any major mishaps. Perhaps the next big crisis will reveal unexpected fault lines, but they are as likely to crop up in the universe of active mutual and hedge funds.

Dr Burry’s more nuanced point — that the rising importance of index funds means that smaller companies that haven’t made it into one of the more popular benchmarks are unfairly shunned — is valid. Yet the bonds and stocks of tiny companies have always been largely ignored by most investors. Although the valuation gap between indexed heaven and below-benchmark hell is widening, likely due to index funds, this surely just means richer opportunities for money managers to exploit.

The bigger, still under-appreciated issue surrounding index funds are the benefits of scale and swelling corporate power that accrues to the biggest investment groups.

This is something that even Mr Bogle noted before passing away in January. But for the foreseeable future, the “index fund bubble” is a bubble that benefits every investor in the world. Long may it continue to inflate.

The Battle Over Ecuador’s Economic Reforms

Protesters are decrying government reforms undertaken at the behest of the International Monetary Fund.

By Allison Fedirka


Ecuador is nearly a week into a government-declared state of emergency after President Lenin Moreno’s Oct. 1 announcement of a slate of economic reforms sparked widespread protests. Despite the state of emergency, indigenous communities, unions and civil society organizations convened in the capital, Quito, again on Wednesday to protest the government’s most recent economic and austerity measures. Moreno was so perturbed by the past week’s protests that on Monday he ordered the seat of government moved out of Quito.

The backlash is aimed at more than just Moreno’s administration, however. Demonstrators are also decrying what they see as the co-conspirator behind the government’s reforms: the International Monetary Fund. Moreno’s government signed an IMF agreement earlier this year that laid out measures to stimulate Ecuador’s stagnant economy, fortify the country’s dollarization (it adopted the U.S. dollar as its currency in 2000), create jobs, increase competitiveness, protect vulnerable sectors and improve anticorruption measures. The IMF’s plan may have been theoretically and technically sound, but it did not reflect Ecuador’s reality and it went awry upon implementation.

No Good Options

Moreno’s predecessor, Rafael Correa, oversaw a decade of socialist-populist governance that created significant distortions in the economy. Moreno inherited an economy hobbled by the 2014 drop in oil prices, high public debt and severely depleted international reserves. Reforms were necessary. But rather than trying to fix the entire mess in one fell swoop, Moreno adopted a gradual, piecemeal approach to normalize the economy and adopt more open-market policies. The changes were unpopular – reflected in Moreno’s approval ratings – but his approach allowed him to make important changes without generating serious public backlash.

Earlier this year, however, Moreno, still dealing with fiscal imbalances, a sluggish economy, limited domestic resources and the threat of a global economic slowdown, turned to the IMF. The two reached a deal in February 2019.
The IMF package totaled $10.2 billion, of which $4.2 billion was a loan, and came with austerity and government spending restrictions attached. The package generally followed the trajectory of Moreno’s existing efforts, but the IMF mandated a more aggressive approach. In short, the terms set forth by the IMF carried with them high social and political risks, which could jeopardize the overall economy.

On Oct. 1, the president announced a series of measures to reduce Ecuador’s fiscal deficit, in line with the IMF’s requirements to tighten up government spending. Most controversial, the government said it would eliminate fuel subsidies, which would save it $1.4 billion annually. Other measures included increasing select value-added taxes, allowing temporary labor contracts, reducing paid vacation time for public employees and withdrawing tariffs on capital goods and raw materials. In all, the government would see a $2.27 billion benefit each year from the changes – equivalent to nearly 6 percent of gross domestic product. Protests began less than 24 hours after the announcement and spread across the country over the next few days, resulting in road blockades, vandalism, arrests and clashes between protesters and security forces. The government has deployed the military and other security forces to restore and maintain order, so far with limited success.
Culture Clash
Ecuador’s current unrest reflects a major shortcoming of the IMF: It is an institution designed by and in the image of the developed world (in particular the United States and the European Union) but which primarily supports emerging economies. As a result, its policies frequently fail – or create socio-political crises in recipient countries. The IMF typically conditions its aid packages (which often include loans) on a recipient country’s compliance with its stringent policy requirements. From the IMF’s perspective, this is a way to guarantee that its funds will help solve the underlying economic problems at hand and ensure that a government will make the policy changes it prescribes (whether or not those are the changes the recipient needs). 

But from a recipient’s perspective, the IMF is imposing the solutions of Western (and, in this case, Northern), developed economies on Southern, less-developed economies. The realities of the IMF and its recipients are very different, and indeed, recipient countries often chafe against this prescriptiveness, at times resulting in social and political backlash that can jeopardize an entire economic recovery plan.

For decades, the U.S. and Europe, as leading economic powers, have provided loans, aid and development funding to emerging economies. Institutions like the IMF painstakingly outline on paper what they believe is the perfect formula for solving an economic problem. In August, for example, the IMF Blog published an excerpt from a working paper that calls for the elimination of fuel subsidies. It argues those funds will be better spent on investments in health and education, particularly in emerging economies. And yet in practice, the formula has ignited explosive social and political consequences. Even with the promise of long-term payoffs, the proposal reflects the IMF’s blindness to the deep political and social impacts that can jeopardize and work directly against said long-term goals.


This reality has hit Moreno hard. Since the government announced the new measures, it’s been engaged in social and political triage. The administration negotiated a settlement with transportation workers, allowing them to increase rates to make up for increased fuel prices. But this sparked fears of rising costs across the board, and cases of speculative pricing of goods have already been registered, prompting the government to put in place price controls on some basic goods.
Demonstrators’ complaints are rife with anti-IMF sentiment; they have criticized its “neo-liberal” model (a phrase that in Ecuador has negative connotations), rejected its U.S.-led policies and asserted that the Fund has no place in Ecuador.
The politically influential Confederation of Indigenous Nationalities of Ecuador (or CONAIE) declared a state of emergency of its own on ancestral lands, citing the government’s use of force and failure to understand the popular nature of protesters’ demands, and threatened to subject any government security forces who violated the decree to indigenous law and punishment. CONAIE’s protests have also targeted the engine of Ecuador’s economy. The group has questioned the government’s handling of the oil and mining industries, and the state oil company, Petroamazonas, has suspended work in three oil fields because of the unrest.

Ecuador has clashed with the IMF before. In the late 1990s, the country was in the midst of an economic crisis in the lead-up to its dollarization. Jamil Mahuad was elected president in August 1998 with hopes that he could help fix the economy. Mahuad told the IMF he would manage the crisis and fix the deficit without its help. In his first months in office, he cut subsidies, raised prices and devalued the exchange rate band by 15 percent. Just over a year later, Ecuador notified the IMF that it intended to adopt the dollar, defer select debt payments and request financial assistance. Within two weeks of the dollarization announcement, CONAIE banded together with midlevel military officers and ousted Mahuad from office.

The strings attached to the IMF package have raised social and political issues that challenge the core of the country’s governance and social makeup. Austerity measures are rarely well-received by the general population, but it’s a jump from a few protests to weekslong demonstrations that bring together multiple pillars of society seeking to completely override, undo or replace the government. For Ecuador, finding a way out of its dire economic straits will require either choosing the lesser of two evils – either the social unrest that comes with the IMF deal or continued economic malaise – or concocting some other domestic solution. Moreover, there’s little the IMF can do to support the Moreno government’s efforts to address these massive social consequences.

Lender of Last Resort

Cases like Ecuador’s reignite a debate over the role and effectiveness of institutions like the IMF. The U.S.-based Center for Economic and Policy Research recently published a report concluding that the IMF loan will do more harm than good in Ecuador and criticizing the lender for its baseline assumptions. Harvard Professor Kenneth Rogoff, inspired by the situation in Argentinahas called on the IMF to reassess how it handles emerging economies. He highlights the recurrence of economic crises in past IMF recipient countries and points out the failure to prevent relapse. His proposal envisions a heavier emphasis on the aid component and less on austerity. The discourse over a global lender of last resort gains importance in the context of an expected global economic slowdown and growing concerns of debt crises in emerging markets.

Still, the governments of emerging economies continue to apply for IMF loans despite the Fund’s arguable ineffectiveness and propensity to offer solutions that just cause more problems. It may be because the IMF has long been the global lender of last resort, and because there are no consistently good alternatives. But trying to force IMF solutions on emerging economies too often results in a package that doesn’t reflect the realities of the recipient country. And from that standpoint, the unintended and dramatic socio-political consequences should come as no surprise.

The euro’s guardians face a roar of the dinosaurs

The true risk to the eurozone economy is overly tight, not loose, monetary policy

The editorial board

16.08.2019, Hessen, Oberursel: Helmut Schlesinger, früherer Präsident der Deutschen Bundesbank (1991-1993), spricht während eines Interviews in seinem Privathaus. 1972 bis 1991 war er Mitglied im Direktorium sowie Chefvolkswirt der Bundesbank. Am 4. September 2019 wird Schlesinger 95 Jahre alt. Foto: Arne Dedert/dpa | usage worldwide
Helmut Schlesinger, the former Bundesbank head, is one of the signatories of a memo attacking the European Central Bank © DPA

The attack on the European Central Bank’s renewed stimulus by six former central bankers is extraordinary. Already, the ECB had been publicly criticised in unusually sharp terms by dissenters on its own governing council and leading German financial executives. }

But the new critics, in a memo published on Friday, include some of the grandest names in central banking, such as Helmut Schlesinger, the 95-year-old former Bundesbank head, and Otmar Issing, an ECB board member when the euro came into being.

Only one thing can match the stature of the complainants and that is the hollowness of their complaint. Their memorandum reveals them as the Bourbons of central banking: they have learnt nothing and forgotten nothing.

They think monetary accommodation has damaged the financial sector, turned banks and companies into zombies, and increased the risk of financial instability. But if the history of the euro and global economic evidence demonstrate anything it is that the true risk both to the eurozone economy and to the ECB’s mandate is a policy that is too tight, not one that is excessively loose.

The memo disregards the fact that the last time monetary policy was tightened in the eurozone it helped tip the economy into a second recession, and unchained deflationary pressures that were only reined in by a belated programme of quantitative easing. Other central banks, which loosened earlier and more ambitiously than the ECB, saw uninterrupted recoveries.

The memo ignores the fact that low rates are a global phenomenon, as is the latest slowdown.

From Japan to the UK, central banks are keeping policy rates at historic lows. The Federal Reserve has reversed its tightening and thinks it may have gone too far in selling off bonds bought in quantitative easing. If the signatories are right, it is not just the ECB but the entire outside world that is mistaken.

Behind a veneer of economic and legal argument lies a partisan attack. The memo is unconvincing in light of the ECB’s mandate to support all-eurozone price stability and the EU’s other economic objectives. It makes more sense as a camouflaged fight for the interests of savers against those of borrowers. Only one signatory is not from the big net saving economies of Germany, Austria and the Netherlands, and the memo all but accuses the ECB of violating EU law to “protect heavily indebted governments”.

Particularly revealing is the complaint that loose monetary policy favours “real assets” and deprives the young of “safe interest-bearing investments”. Rates are low because too many seek riskless savings and too few want to invest in “real assets” — also known as productive capital. If bank deposits do not pay the returns they once did, the fault is not that of central banks but of market realities. Holding back demand with tighter money can only make things worse.

If they really wanted higher rates, the critics would support the ECB’s call for fiscal expansion to relieve monetary policy. Instead their hard money dogma reflects a deeper disagreement that predates the euro, over whether Europe is governed in Germany’s image or Germany in Europe’s. Wolfgang Schäuble infamously blamed low ECB rates for the growth of the far-right Alternative for Germany. In fact the populist party’s origins lie in the sort of hard money lobbying for savers’ interest that the memo represents — never mind that the ECB has kept inflation lower than the Bundesbank.

The memo expresses a generation’s frustration that its ideas lost influence. Today’s Europe — especially its youth — may be fortunate that they did.

Why More Rate Cuts Could Help Prevent a U.S. Recession

Wharton's Jeremy Siegel interviews St. Louis Fed President James Bullard about the economy and the markets.

In this interview with St. Louis Fed President James Bullard, Wharton finance professor Jeremy Siegel covers a range of topics including interest rates, the outlook for the economy, the recent tumult in the repurchase agreement (repo) markets and the inverted yield curve. The discussion also touched on the economic challenges posed by the trade war with China, which Bullard sees as one downside risk in an otherwise robust economy.

Bullard favors an additional 25-basis-point cut in the Fed Funds Rate that could help the U.S. economy “power through” recent signs of economic weakness and extend the longest economic expansion since World War II. Joining the discussion, which occurred on Wharton Business Radio’s Behind the Markets show on SirusXM, was moderator Jeremy Schwartz from WisdomTree ETF Investments. Below are edited excerpts from the interview.  
Interest Rate Levels

Bullard discussed his dissent on the decision by the Federal Open Market Committee (FOMC), in a 7-3 vote, to lower short-term interest rates by a quarter point on Sept. 18. He favored a half-point cut.

Jeremy Schwartz: Jim, maybe you could start with your overall look of the world and why you felt [the FOMC] should cut 50 basis points.

James Bullard: I dissented at the meeting. I … basically cited the idea that inflation and inflation expectations are quite low in the current environment, so that probably gives us room to maneuver. Manufacturing and industrial types of companies aren’t doing very well in the current environment. It looks like they’re in contraction mode. So I cited that.

Global growth is low. The trade war is having a large impact outside the country and some impact inside the country on sectors like agriculture. And then you’ve got the inverted yield curve. I don’t think we have a good reason to have the policy rate in the U.S. be higher than almost all sovereign yields out to 10 years across the G7 (Group of Seven countries).

Schwartz: Do you worry about lowering interest rates more, sooner — that it may take away ammo you might need later? What are the tools you guys would consider after that?

Bullard: Yes, if there were a really big shock, then we would have to lower rates down to zero, and we’d have to consider unconventional monetary policy again. But I don’t think that’s the situation we’re in right now. What we have now is just a pretty good overall performance of the U.S. economy, certainly great labor markets, good consumption growth. We’ve got some sectors in industrial and agriculture that maybe aren’t doing very well, partly because of the trade war. We’ve got slowing global growth. So we’ve got some downside risk in what is otherwise a high-performing economy. The idea here is to take insurance out against the idea that this downside risk manifests itself in much slower growth in 2020.
If all goes well, this insurance will pay off, and we’ll be able to power through the downside risk. Those risks will subside, and we won’t have any recession. Then we can raise the policy rate back up, and then we’d have plenty of ammunition for those who are concerned about that in the future. This is a good way of thinking about how to manage the risks for the U.S. economy. We do have occasions in the 1990s where this worked very effectively, and I think we should play this expansion the same way we played that one, and hopefully we’ll get an even longer expansion than we otherwise would.

What I like to do is get the policy right to the point that we think rates are where they should be, and then react to data going forward from there. We haven’t quite been as nimble as we could have been over the last couple of months, but we’re still moving in the right direction, and I penciled in one more cut for the rest of the year — although I’d reserve judgment [based on] the data coming in between now and the meeting. I also think that these are insurance cuts, so it’s very possible that we’ve done enough — or will have done enough by the end of the year.

The U.S. Economy 
Jeremy Siegel: Things did look, a week and a half ago, pretty scary when the ISM (manufacturing index) number came out under 50 for the first time in three years, and the components were really weak. Then, in the last 10 to 12 days, there have been surprisingly very good economic data. Both Bloomberg and Citi’s economic surprise indicators show the U.S. actually hitting a 12-month high. Have you been surprised by some of the strength that we’ve been seeing, and some of the recent data we’ve been getting?

Bullard: Well, not really because I think we have a very strong labor market which is underpinning good consumption growth in the U.S. and a household sector that, generally speaking, is doing well. But around that, we have the trade war going on. We have businesses that are partly dependent on income from overseas. The overseas growth rate is slowing, possibly precipitously — Europe in particular looks like it might be teetering on recession.

Also [China’s economic growth is] much slower than would have been otherwise predicted. So it’s not surprising that you would get good numbers that are related to domestic factors that aren’t too far from household spending here in the U.S. But nevertheless, you would see other companies that are global operators doing poorly, and sectors that are directly affected by the trade war — like agriculture — doing poorly. And so you’ve got disruption going on in some parts of the economy, but good times in other parts of the economy. You’re going to see a mixed message from the data, I think.
Siegel: One of the very few differences of the [latest FOMC] statement compared to the previous one was you added exports to business spending as one of the weak points in the economy. So your point, I think, is certainly well taken on those exports.

Unusual Stress in the Repo Market

Bullard discussed the recent sharp, but short-lived, signs of stress in the repurchasing or repo market. (A repo agreement is a short-term borrowing transaction, often just overnight, used typically by dealers in government securities. Often a dealer will sell government securities overnight to raise money to fund other purchases of securities, and settle the accounts the following day if they are not rolled over.)

Overnight borrowing costs shot up — from 2.2% on Sept. 16 to 6% the following day. Such a large spike had not been seen since just before the financial crisis. Normally the market has more than enough money to remain very liquid. But this time, according to press reports, it appeared that a tax payment deadline for big companies, a holiday in Japan, and a recent auction of government bonds that sucked up funds led to the brief squeeze — and created a kind of perfect-storm credit squeeze that officials claim did not go out of control.

Siegel: The disturbances that we saw in the repo market really took everyone, maybe even the Fed, by surprise…. [Fed Chair] Jay Powell implied that they didn’t expect it. We know the banks have what’s called an “ample reserve” system — excess reserves, hundreds of billions of dollars, if not trillions. They were getting 2.15%, 2.10% on that.

Why didn’t the banks step in and lend it to the dealers and say, “Hey, listen, I can lend you the cash that you need to do that settlement.” Were they just not set up to lend in the repo market, or was it because it just came on so suddenly? Shouldn’t that have happened under an excess reserve system? Could you give us your take on that?

Bullard: This issue is about volatility in short-term funding markets. There was a time years ago … when these markets would have been that volatile every day. … They’ve been so tame in recent years that this turned out to be a headline event. Yes, we do have ample reserves. It sounds to me like there were special factors in the market. We’re trying to learn more about that as time goes on. There are some tax payments going on, and for one reason or another, the match-up between borrowers and lenders wasn’t as smooth as it would have been on other days.

I’ve suggested in the past that we should look at a repo facility to complement our reverse repo facility. In my view, that would bring us closer to an international standard on how this is done by other central banks. We’ve actually blogged about this — some of our economists here — and listeners can look that up if they want. But I think that’s something that maybe should be considered and then we wouldn’t have to worry about this.
Siegel: I’m trying to understand the reasons why it isn’t as tight as it seemed to be in those earlier years.

Bullard: I guess what markets are saying is, “Well, there are less reserves than there were.” So that’s a fact. Our reserves are down a good 40%, 50% from off their peak, but it’s still an ample reserves regime. I think there are special factors. The market is quirkier than it once was because rates are so low and lots of institutions aren’t trading there the way they would have in the pre-crisis era, so it’s not quite as thick of a market as you would otherwise think. So I think we’ll keep an eye on this, and I think we have plenty of ways we could address this situation.

Trade War and Financial Risk

Schwartz: In your dissent and wanting a larger rate cut — an insurance policy — you said there’s one risk to the upside for the economy. What would make the economy do better than you were expecting?

Bullard: We could be just overestimating the impact of the trade war, and it won’t be nearly as large. And in that case, we might want to take some of these insurance cuts back. Right now that’s not what I’m thinking, but it’s possible that we could go in that direction.

Negative Interest Rates

Siegel: If you look at Europe, it’s growing slower. Its GDP is about 1% less (than U.S. GDP), but its short-term real interest rates are minus 1-1/2 to minus 2 at present. Even if you compensate for the difference of GDP growth in the United States and Europe, you still don’t get as high a difference in rates as it seems the Fed thinks there should be. As an FOMC member, that’s another way to think about the fact that the real short-term Fed funds rate could really have dropped below zero.

Bullard: A lot of people have been pointing out that there are more than $15 trillion in sovereign yields that are negative nominal today, and that seems to be growing. I think we have to just face up to the idea that it’s an extremely low-interest rate environment globally, and U.S. yields can’t get too far out of line from those global yields, even though our economy is somewhat better than some other places in the world. That’s not enough to allow the hundreds of basis points differential between the U.S. and other countries.
An Inverted Yield Curve

Siegel: We may be seeing a flatter yield curve as a normal state of affairs. It seems like long Treasuries have become a very favorite hedge asset of many holders. They move in the opposite direction of the stock market and risk assets, and as a result, there’s a tremendous demand for them. And that would tend to bend down the curve. We might be seeing much flatter curves going forward than what we’ve certainly experienced in the past. Have you given any thought to that issue?

Bullard: Well, it’s certainly possible that trading patterns are changing, and the status of the U.S. 10-year is different than it was…. But you’re right, the (recession-prediction reliability of the inverted yield curve) — the track record — has been so good over the post-War era that I’m just reluctant to try to test some theory about why you think yield curve inversion is all right this time. And we don’t really have to. Inflation is below target, and inflation expectations are below where we’d like them to be. So we have some room to maneuver on this.

When you get into yield curve stories, there are always different points on the yield curve that you can compare. And the 10-year/2-year is one of the most common. That one hasn’t quite inverted on a sustained basis during this 90-day period here, and I take a little bit of heart there, because the 2-year part of that spread is anticipating that the Fed will lower rates somewhat, and it may be just enough to keep the inversion from occurring, and maybe just enough to keep us out of the recession prediction that you would otherwise get from that.

So whether the committee does that in a couple of different steps or does something more aggressive, like I was recommending at this last meeting, the market takes all that into account in the 2-year part of the 10-year/2-year spread.

Britain and the United States

By George Friedman

The United States and Britain have agreed to sign a trade agreement by next July, The Sun newspaper reported on Monday. The accuracy of the story is not yet clear, but for Britain, leaving the European Union and building a closer trade relationship with the United States, and therefore with North America, follows geopolitical logic.

Britain’s historical stance toward Europe was to try to maintain a balance of power on the Continent so that no force there would be able to threaten British sovereignty. One force driving British imperialism was the need to develop markets and sources outside Europe so as not to become excessively dependent on Europe. The Royal Navy was designed both to protect Britain from continental powers and, in time of war, to blockade hostile European powers without being excessively drawn into combat on the Continent. The British hesitated for a long time before agreeing to join the European Community and the powers on the Continent (particularly the French) hesitated for a long time before admitting them. The British were instrumental in creating the “Outer Seven” bloc of nations on the Continent’s periphery as an alternative to what would eventually become the European Union.

For Britain, the consolidation of the Continent into a single bloc was a perpetual nightmare. Britain was militarily weak compared to the Continent as a whole and saw Napoleon, for example, as an existential threat. Had he been able to impose a stable system, dominated by Paris, on the Continent, the economic and military force he could have mustered would have overwhelmed Britain’s naval defenses in the not-too-long run and compelled Britain to accommodate itself to French hegemony. In this hegemony, it would have found itself at a perpetual disadvantage (as would other nations) as France tilted the economic system in its favor. It therefore joined the anti-Napoleonic alliance and, after Waterloo, cautiously withdrew from the Continent and focused on its empire.

With the unification of Germany in 1871, however, Britain was drawn into Europe once again. It first found itself in economic competition with the new European power, then in political competition over empire, and finally was drawn into the two world wars. The point that must be borne in mind was that membership in a European bloc ran counter to historic British views of Europe. The British fear was that the constraints imposed by any European alliance would inevitably tilt the economic system against Britain and threaten its sovereignty.

World War II left Britain in a difficult position. It had essentially bankrupted itself in the war against Germany. The effort to resist the Continent in order to guarantee its sovereignty and prosperity had preserved sovereignty at the price of prosperity. It had also decisively brought another nation into the dynamic: the United States. At the end of World War I, the United States had the same perspective as the British. A German victory would unite Europe and create naval forces that would limit U.S. access to the seas. The U.S. wanted the same thing Britain had wanted: to prevent a single hegemon from controlling the Continent, and therefore to maintain division of the Continent through a balance of power. This was the intent of the Treaty of Versailles, which blocked France from dismembering Germany and achieving Napoleon’s goal of dominating the Continent. Versailles also set the stage for World War II, once Germany had reorganized itself.

From unification onward, Britain’s primary threat was not France but Germany. World War I settled the problem only temporarily, drawing both the British and Americans into a war on the Continent. The conflict also reversed the relationship between the United States and Britain. Neither had fully trusted the other. After World War I, the U.S. maintained a set of war scenarios that included War Plan Red, which was based on a potential British invasion from Canada. Far-fetched as this might seem now, Washington had seen the British as a threat during the Civil War less than 50 years before, as well as a naval challenger in 1900. Britain saw the American economic surge as a threat to its markets and vigorously limited U.S. economic relations with the empire. In 1920, the mutual suspicion continued; indeed, when lend-lease was enacted, the U.S. lent ships to Britain – but Britain leased almost all of its bases in the Western Hemisphere to the U.S., ending centuries of domination of the Atlantic and a perpetual threat to the United States. The two countries cooperated in World War I, but isolationists in the U.S. remained suspicious of British motives in the war.

World War II ended with Germany partitioned, the British Empire crumbling and the United States the dominant power. The U.S. and Britain were allied in the conflict, but it would be a mistake to think they were close partners. In 1956, the U.S. blocked Britain (and France and Israel) from retaking the Suez Canal. President Franklin Roosevelt had made it clear that the U.S. was fighting to defeat Germany and not to save the British Empire. The two countries were imperfectly aligned, to say the least.

The Marshall Plan made European economic integration a prerequisite to recovery. In a way, the EU originated as a U.S. plan. But the U.S. focus was not European integration. Washington was worried about the Soviets and wanted a prosperous, united Europe that could field a military. The British were uneasy about integration, and the French were cautious about Britain. The old tensions did not dissolve. Nor did German weakness. The U.S. needed Germany to recover, since Germany would be the battleground of any future war. And so it did, and over time an integrated Europe became a German-dominated Europe, benign militarily, aggressive economically.

The British had to develop a new grand strategy suitable for their new position. Britain’s strategy was to maintain its distance from Europe by building a special military and intelligence relationship with the United States, while cautiously dipping its toes into European integration. In other words, the British managed to maintain a European balance of power while at the same time creating a balance between Europe and the United States, using the space this opened to pursue their own interests.

The Brexit deadlock today is over the same issues: sovereignty and prosperity. For Britain, the EU delivered a degree of prosperity at the loss of a degree of sovereignty. This arrangement could work if it was meticulously balanced. But the EU was not a flexible entity in which Britain could work its historic subtlety. This split Britain down the middle between those who had not experienced prosperity and resented the loss of any degree of sovereignty and those who had experienced prosperity and did not value sovereignty. The damage to the United Kingdom’s stability was substantial, the fear of declining prosperity real.

This has forced Britain to look to the United States as it had during the 20th century. Britain’s military and intelligence relationships with its former settler colonies (the United States, Australia, New Zealand and Canada) were an important dimension of its global vision. They were also foundational to the American alliance system, with all five countries participating in the “Five Eyes” intelligence-sharing group and maintaining intimate military cooperation. Canada and Australia have significant trade agreements with the United States, and New Zealand is negotiating one.

Britain sees this structure as an alternative to the European Union. On security matters, Britain is already part of this coalition. Economically, North America’s total gross domestic product is larger than that of the EU. Add Australia, New Zealand and Britain and this economic group is substantially larger than the European Union and, in many ways, more dynamic. And given U.S. sensitivity over its own sovereignty, it does not make demands on social and political harmonization, nor does it dictate rules on migration. Britain already conducts substantial trade with all four nations, which requires a degree of integration, but it’s limited to market access on favorable terms.


The problem for Britain, however, is that a shift in economic posture would end the long-term balance of power strategy. On the other hand, staying in a bloc that has no interest in the internal harmonization of Britain would be damaging. A shift would be complex and painful, but the pain Britain is feeling now from the split inside of its country is at least as unbearable.

If Britain shifted economically to this bloc, we would be seeing the emergence of a loose economic and security alliance. It would be a bloc of the settler colonies Britain spawned. The weight of this group in world affairs would be massive. For the United States, this would be nice to have. For the Canadians, it would be more tense. For the Australians and New Zealanders, it would be business as usual. But nowhere would it be as fraught with tension as in Britain. Brexit is going to happen, and Britain must imagine what life will be like after its withdrawal. A trade agreement with the United States is the logical and even inevitable step, but one with long-term significance.

A Strawman in England

FC Barcelona, a Shell Company and Messi's Father

By Rafael Buschmann and Michael Wulzinger

Lionel Messi and his father Jorge in court in Spain in 2016.

The London-based company Sidefloor was part of the tax-evasion structure for which Lionel Messi and his father Jorge were convicted. Now it has been revealed that FC Barcelona spent years paying agent fees to this letterbox company, payments apparently destined for Jorge Messi.

Spring 2016 saw the beginning of an audit at FC Barcelona. Four officers belonging to the large-company division of Agencia Tributaria, the Spanish tax authority, had stumbled across multi-million-euro payments from the football club to Lionel Messi's charitable foundation.

As documents from the whistleblower platform Football Leaks show, the inspectors demanded that the club supply all documents pertaining to payments to Fundación Leo Messi, which prides itself on assisting needy children, from the years 2010 to 2013. The auditors wanted precise information that could shed light on why Barcelona had made the payments.

In addition, the tax officials hoped to learn more about payments made to the agents representing Barcelona players. Pressured by the Agencia Tributaria, FC Barcelona executives reconstructed all payments made by the club during the preceding seven years to agents working on behalf of Lionel Messi.

It was a sensitive undertaking, in part because the audit of FC Barcelona was taking place at a time when Lionel Messi and his father Jorge were being charged on suspicions of tax evasion and abetting tax evasion. The trial began a short time later, with a regional court in Barcelona ultimately sentencing the player to a 21-month suspended prison sentence. His father initially received the same term.

The judges were convinced that between 2007 and 2009, Lionel and Jorge Messi had hidden more than 10 million euros in marketing revenues from the Spanish tax office "with the help of a strategy" involvingshell companies based in tax havens, ultimately cheating the state out of 4.1 million euros in tax revenues. In May 2017, the highest Spanish court reduced Jorge Messi's sentence to 15 months, but the upshot was that both he and his son Lionel now had prior convictions. Any additional tax-related missteps could prove dangerous.

Offshore System

One of the letterbox companies in the Messis' tax-evasion network bore the name Sidefloor Limited. Based in London, it took care of marketing contracts for Lionel Messi and earned a commission of between 5 and 8 percent for doing so. The director of Sidefloor was the Briton David Waygood, who also headed up more than 100 additional companies.

Sidefloor Limited suddenly made a reappearance thanks to the audit of FC Barcelona in spring 2016. Documents from Football Leaks show that the club made 13 Lionel Messi-related payments in the period from June 2009 to June 2014, adding up to precisely 6,695,005 euros. According to the documentation, Barcelona made the payments to Sidefloor in London's Bedford Row, the exact same company that the Spanish judges ruled to be an important part of the Messis' offshore system.

These payments raise several questions. Was much of the 6.7 million euros paid to Sidefloor transferred onward to Jorge Messi for his work as an agent? And if so, did Jorge Messi reveal these payments to the tax authorities? It is enough to arouse suspicions that Sidefloor was used -- just as it was for Messi's marketing revenues -- to obscure the true recipient of the agent fees.

Only since 2015 has Jorge Messi had FC Barcelona pay his fees to a company, of which he is the director. The company is called Limecu, the name a fusion of the first letters of the player's full name: Lionel Messi Cuccittini. Documents show that between October 2015 and June 2016, when the audit took place, Barcelona wired 3,788,000 euros to the company, which is based in the Messis' hometown of Rosario, Argentina.

From a formally legal perspective, everything seemed to be on the up-and-up when it came to the agent fees paid to Sidefloor, with the London-based company being named as FC Barcelona's contractual partner for the Messi-related payments until mid-2014. The club and Sidefloor, represented by director Waygood, had apparently agreed to an agent contract on Oct. 10, 2008. Just a few months before that, on July 4, Lionel Messi had extended his contract to the end of 2014 -- "with the help of Jorge Messi," as is noted in a draft of the agent contract. According to the draft contract, FC Barcelona was to pay Sidefloor a provision of 400,000 euros each year for as long as Lionel Messi played for the club, "plus a sum equal to 5 percent of the bonuses the player receives."

This 5-percent deal for Sidefloor was apparently still valid on Feb. 7, 2013, when Lionel Messi again extended his contract with the club, this time until the end of June 2017. The player's income increased significantly, with his annual salary now at 18.6 million euros. His bonuses also skyrocketed.

Little More than a Strawman

And Sidefloor was still to receive its 5 percent. Director Waygood signed Lionel Messi's new contract as an "agent." Jorge Messi also affixed his signature to the document. Interestingly, FC Barcelona misspelled Waygood's name at the spot where the Englishman was to sign, writing "Waygoog" instead. The error would be repeated in a different document. But nobody seemed particularly bothered. After all, Waygood was likely intended as little more than a strawman.

On that Feb.7, 2013, when Lionel Messi once again extended his contract with FC Barcelona, the football club and Sidefloor director Waygood apparently signed an additional deal, a "service contract." DER SPIEGEL has obtained a draft of that contract, according to which Barcelona was to begin making annual payments to the London-based letterbox company of 280,000 euros, payable in two installments, for "talent scouting in Argentina." When an FC Barcelona staffer ran across these payments in July 2016 in connection with the audit, he wrote an email to the club's chief legal representative and to Jorge Messi's lawyer: "There are a couple of invoices pertaining to services that we have discovered. I have attached them to this message."

Whether and how Sidefloor transferred the agent fees from FC Barcelona onward to Jorge Messi is not apparent from the Football Leaks documents. But it is possible that the shell company functioned here too merely as a way station to obscure money flows.

The choice of bank is a potential indicator: a Luxembourg branch of the Andorran financial institution Andbanc, traditionally one of Europe's most secretive financial centers. Nothing would have been easier for Sidefloor than to send the money onward to a company under the control of Jorge Messi without having to face any uncomfortable questions.

Among the Football Leaks documents, there is a draft of an agreement from July 2013 between the club, Lionel Messi and Sidefloor according to which the superstar would be prematurely extending his contract that had just been extended to June 2017 by an additional year. For FC Barcelona, the club's then president, Sandro Rosell, was to sign the deal while director Waygood, identified as "agent" in the draft contract, would be signing on behalf of Sidefloor.

Too Much

Just one year later, Messi's salary was to see yet another massive increase, at least according to a draft contract dated May 14, 2014. This deal was to be signed by the new president of FC Barcelona, Josep Maria Bartomeu, Lionel Messi himself and, again, Waygood as "agent." Yet even as FC Barcelona composed the two new draft contracts, again misspelling the agent's name as Waygoog, the Messi family's strawman was no longer among the living. David Waygood had thrown himself in front of a train on April 27, 2013, not far from his home in the county of Kent.

At the time of his death, the British regulator Financial Conduct Authority was apparently preparing to investigate a company under Waygood's control. Officials determined that "work-related stress" contributed to the suicide. It is impossible to say whether a role was played by the investigation being conducted by Barcelona prosecutors into potential tax evasion and abetting tax evasion by the Messis and their connection to the shell company Sidefloor.

A neighbor who lived two doors down from Waygood and who claims to have been friends with him merely told DER SPIEGEL that it was ultimately all too much for him. Waygood left behind two grown children, neither of whom responded to a request for comment. Neither FC Barcelona nor Jorge Messi commented on the payments made to Sidefloor. David Waygood's successor as Sidefloor director likewise did not respond to a DER SPIEGEL inquiry.

This article is an excerpt from a new book based on data from the whistleblower platform Football Leaks. The book, "Football Leaks II: Neue Enthüllungen aus der Welt des Profifußballs," appeared in German on Monday, September 9.