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Pope Francis promised to clean up the Vatican’s murky finances

The Economist - Thu, 11/21/2019 - 15:55

AFTER A WEEK of resignations and exclusions, the Vatican faces the very real risk of being reduced once more to the status of an international financial pariah. In the coming days its officials are due to answer a detailed questionnaire for Moneyval, Europe’s anti-money-laundering and anti-terrorist-financing watchdog. The picture they will have to paint could scarcely be less reassuring.

The Financial Information Authority (AIF)—the Vatican’s regulatory body and the cornerstone of a nine-year campaign to dispel the Holy See’s image as a refuge for hot money and shady dealings—is no longer eligible to receive intelligence on suspected financial crime from its counterparts in other states. The AIF’s president, René Brülhart, has left (the Vatican announced on November 19th that his contract would not be renewed). Half his board has since resigned. And the authority’s director is suspended from duty.

Earlier this month the Egmont Group, a network of more than 160 national financial-intelligence agencies, barred the AIF from the secure communications system its members use to swap information. The decision, reported on November 20th, was not unexpected. Last month the Vatican’s gendarmes raided the offices of the AIF and the Secretariat of State, the Holy See’s equivalent of a foreign ministry. They were acting on a...

What next for Europe’s banking union?

The Economist - Thu, 11/21/2019 - 15:55

ACCORDING TO AN analogy popular in Brussels, the euro zone is a house that needs fixing. Everyone frets about its ability to withstand a gale. But the builders are nowhere in sight. The owners cannot agree on the repairs that are needed, much less on how to do them. When Olaf Scholz, Germany’s finance minister, cautiously accepted the idea of a common deposit-insurance scheme on November 5th, that removed one point of contention. But as one row is resolved, another—on the regulatory treatment of banks’ holdings of sovereign debt—has reopened.

An infamous feature of the sovereign-debt crisis in 2009-15 was the “doom loop”, through which weak banks and sovereigns dragged each other down. In 2012 members agreed that the doom loop needed to be broken, and the monetary union backed by a banking union. A common supervision and resolution framework for large banks has since been set up. But barely any progress has been made on common deposit insurance, because northerners are terrified that their taxpayers would be liable for risky loans made by southern banks, to their home governments among others. Now Mr Scholz seems amenable—provided other reforms happen. The most contentious would penalise banks for holding heaps of their home countries’ sovereign debt—long a non-starter for Italy and other heavily indebted states.

...

Why currency traders are serene even as Western politics gets messy

The Economist - Thu, 11/21/2019 - 15:55

TRADE WARS; talk of impeachment; the spread of populist politicians and hung parliaments across Europe. It is hardly surprising that an index from Policy Uncertainty, a geopolitical think-tank, puts global economic uncertainty at its highest since the gauge was created in 1997. By contrast, implied euro-dollar volatility is trading at its lowest since the single currency was born in 1999 (see chart).

Derivative contracts indicate that investors think the currency pair, the most traded asset on financial markets, at $400trn annually, will move less than 6% next year. On November 14th the volatility implied by the cost of “call” and “put” options (contracts that grant the right to buy or sell at a pre-agreed price at some future date) fell below the levels of the serene days before the financial crisis in 2007.

Why the disconnect? One explanation is monetary policy on both sides of the Atlantic. The Federal Reserve started to tighten in 2013, tapering its quantitative-easing programme and, from 2015, raising interest rates. In July its first rate cut since 2008 marked a policy U-turn. Its chairman, Jerome Powell, cited global uncertainty as the main reason. In September the European Central Bank (ECB) cut rates for the fifth time over the same period, to -0.5%.

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Firms that analyse climate risks are the latest hot property

The Economist - Thu, 11/21/2019 - 15:55

SOON AFTER Hurricane Sandy battered Manhattan in 2012, Emilie Mazzacurati founded a firm in California to analyse the risks posed by climate change to business. She called it Four Twenty Seven, after the state’s target of lowering annual greenhouse-gas emissions to the equivalent of 427m tonnes of carbon dioxide by 2020. That reference quickly became outdated. The target was adjusted for technical reasons two years later, and rendered moot in 2018 by the announcement of a net-zero goal. Ms Mazzacurati is still happy with the name, though. “That is the risk of doing business in an uncertain climate,” she says.

Such uncertainty has sent financial firms scrambling to buy climate-service providers, as such firms are known. In July Moody’s, a credit-rating agency, bought a majority stake in Four Twenty Seven. In September MSCI, an equity-index maker, snapped up Carbon Delta, a climate-service startup. Wells Fargo invested in Climate Service. In March CO-Firm, based in Hamburg, was bought by PwC, a consultancy. In a funding round earlier this year Jupiter Intelligence, another climate-data outfit, added three insurance firms to its backers.

Most climate-service firms are small startups led by scientists. They use public climate data, usually couched in meteorological terms—that a certain land mass, say, will become on average...

This year’s Nobel prizes prompt soul-searching among economists

The Economist - Thu, 11/21/2019 - 15:55

NOBEL PRIZES are usually given in recognition of ideas that are already more or less guaranteed a legacy. But occasionally they prompt as much debate as admiration. This year’s economics award, given to Abhijit Banerjee, Esther Duflo and Michael Kremer, was unusual both for the recency of the contributions it recognised and the relative youth of the recipients. (For a review of “Good Economics for Hard Times”, by Mr Banerjee and Ms Duflo, see Books and arts section.) Intentionally or not, it has inflamed arguments about the direction of the profession.

The prize, awarded in early October, recognised the laureates’ efforts to use randomised controlled trials (RCTs) to answer social-science questions. In an RCT, researchers assess the effect of a policy intervention by dividing participants into groups, only some of which are treated with the policy. This year’s winners used RCTs to study the effectiveness of anti-poverty programmes in developing economies. To take one example, Mr Kremer suspected that poor health might depress learning by reducing school attendance. By using randomisation to set the schedule by which different schools’ pupils would be treated for intestinal worms, Mr Kremer and his co-author, Edward Miguel, learned that deworming improved health and attendance—but not test scores. Their work has been highly acclaimed,...

Excess Asian savings are weighing on global interest rates

The Economist - Thu, 11/21/2019 - 15:55

IT IS NEARLY 15 years since Ben Bernanke, then the chairman of the Federal Reserve, argued that a “global saving glut” had fuelled America’s giant current-account deficit. Much has changed since then. The American deficit has shrunk, oil exporters’ surpluses have dwindled and central banks everywhere have dramatically expanded their balance-sheets. But another feature of the world that Mr Bernanke described in early 2005 looks strikingly familiar: Asia’s stockpile of savings remains enormous, and it is getting bigger by the year.

For East Asia as a whole, each year gross domestic savings add up to 35% of GDP, and little has changed over the past three decades (see chart). This is not just an academic curiosity. Mr Bernanke’s concern in the early 2000s was that Asia’s excess cash was flooding into bond markets in America and beyond, depressing long-term real interest rates. When the global financial crisis erupted in 2008, some economists pointed to the Asian saving glut as an underlying cause of the housing boom and bust from Las Vegas to Dublin. With interest rates even lower now, some are again asking whether excessive saving in Asia is storing up trouble for the global economy.

There are certainly echoes with 15 years ago. High savings rates in Asia continue to translate into large current-account surpluses. Over the...

How machine learning is revolutionising market intelligence

The Economist - Thu, 11/21/2019 - 15:55

THE THAMES seems to draw people who work on intelligence-gathering. The spooks of MI6 are housed in a funky-looking building overlooking the river. Two miles downstream, in a shared office space near Blackfriars Bridge, lives Arkera, a firm that uses machine-learning technology to sort intelligence from newspapers, websites and other public sources for emerging-market investors. Its location is happenstance. London has the right time zone, between the Americas and Asia. It is a nice place to live. The Thames happens to run through it.

Arkera’s founders, Nav Gupta and Vinit Sahni, both have a background in “macro” hedge funds, the sort that like to bet on big moves in currencies and bond and stock prices ahead of predicted changes in the political climate. The firm’s clients might want a steer on the political risks affecting public finances in Brazil, or to gauge the social pressures that could arise as a consequence of an austerity programme in Egypt. It applies machine learning to find market intelligence and make it usable.

For many people, the use of such technologies in finance is the stuff of dystopian science fiction, of machines running amok. But once you look at market intelligence through the eyes of computer science, it provokes disquieting thoughts of a different kind. It gives a sense of just how creaky and...

Big Tech takes aim at the low-profit retail-banking industry

The Economist - Wed, 11/20/2019 - 21:28

THE ANNUAL Web Summit in Lisbon each year is Woodstock for geeks. Over three days in November, 70,000 tech buffs and investors gather on grounds the size of a small town. Rock stars, like Wikipedia’s boss or Huawei’s chairman, parade on the main stage. Elsewhere people queue for 3D-printed jeans or watch startups pitch from a boxing ring. Money managers announce dazzling funding rounds. Panellists predict a cashless future while gazing into a huge crystal ball. A credit-card mogul dishes out company-coloured macaroons.

Yet the hype conceals rising nervousness among the fintech participants. After years of timidity Big Tech, with its billions of users and gigantic war chest, at last appears serious about crashing their party. “It’s the one group everyone is most scared about,” says Daniel Webber of FXC Intelligence, a data firm. Each of the so-called GAFA quartet is making moves. Amazon introduced a credit card for underbanked shoppers in June; Apple launched its own credit card in August. Facebook announced a new payments system on November 12th (its mooted cryptocurrency, Libra, however, has lost many of its backers and will face stiff regulatory scrutiny). The next day Google said it would start offering current (checking) accounts in America in 2020.

Individually, each initiative is relatively minor, says Antony...

America’s public-sector pension schemes are trillions of dollars short

The Economist - Thu, 11/14/2019 - 16:01

PERHAPS IT TAKES teachers to give politicians a lesson. Any official who wants to understand the terrible state of American public-sector pensions should read the financial report of the Illinois Teachers Pension Fund. Its funding ratio of 40.7% is one of the worst in America, according to the Centre for Retirement Research (CRR) in Boston (see table).

Since it was established in 1939, Illinois officials have not once set aside enough money to fund the pension promises made. As a result, three-quarters of the money the state (or rather the taxpayer) now pays in each year merely covers shortfalls from previous years. The situation is getting worse. In 2009 the schemes’ actuaries requested $2.1bn, but only $1.6bn was paid. By 2018 the state paid in $4.2bn, still well short of the $7.1bn the actuaries asked for. The trustees have warned that the plan would be “unable to absorb any financial shocks created by a sustained downturn in the markets”.

Other schemes have...

The Trump administration is trying to reforge carmakers’ supply chains

The Economist - Thu, 11/14/2019 - 16:01

“YOU WOULD need a magic wand to bring back manufacturing jobs,” said President Donald Trump on November 12th, quoting someone from a past administration. “Well, we brought them back.” The world’s carmakers could be forgiven for wishing he had not bothered. They have been thwacked with tariffs on steel, aluminium and components from China, and threatened with broader levies on cars and car parts in the name of national security. A tariff deadline was looming as The Economist went to press. And they have new rules of the road, in the form of the USMCA, a trade deal with Mexico and Canada.

But despite being pressed to bulk up their American manufacturing presence, there is little sign so far that foreign carmakers are leading an American investment boom. According to Kristin Dziczek of the Centre for Automotive Research, their investments in American facilities have been fairly steady since the recession.

Meanwhile the value of American imports of passenger vehicles and light trucks continues to grow, by 6% in the first three quarters of 2019 compared with a year earlier. Though European car executives were hauled in for a meeting with Mr Trump last December to discuss their American production plans, the value of imported vehicles from the European Union rose over the same period by 2%.

The...

The case for a falling dollar

The Economist - Thu, 11/14/2019 - 16:01

NOBODY WANTS to be called an unthinking optimist. Prospects for the riskier sort of investments are cloudy. The global economy faces numerous threats. Being even mildly bullish can seem a bit unreflective.

So whisper it, don’t shout it, but the mood has changed recently for the better. Since the start of October, global equity prices are up by around 7%. Bond yields have risen. There has been a move away from the safe or defensive assets that hold up in bad economic times, towards those that do well in an upswing (see article). Hopes for a preliminary trade deal between America and China pushed the yuan briefly below seven to the dollar last week.

At times like these, thoughts naturally turn to the outlook for the dollar more generally. A weaker dollar would be both a signal and a driver of a broader improvement in risk appetite. The dollar’s fortunes have not yet shifted decisively. But the conditions for it to weaken are starting to fall into place.

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Tighter production targets have failed to lift the price of oil

The Economist - Thu, 11/14/2019 - 16:01

MEMBERS OF THE Organisation of the Petroleum Exporting Countries, or OPEC, live in a state of uneasy anticipation. Concern about climate change may mean demand for oil wanes in the coming decades. OPEC’s power in oil markets is fading fast. On November 13th the International Energy Agency (IEA), an intergovernmental forecaster, predicted that by 2030 OPEC and Russia, an ally, would pump just 47% of the world’s crude. Yet OPEC has a more immediate problem at hand. 

Global demand for oil has been unexpectedly anaemic this year (see chart ). Sanford C. Bernstein, a research firm, estimates that it may have risen by just 0.8%, the slowest pace since the financial crisis. OPEC and its allies, led by Russia, are due to meet in Vienna on December 5th and 6th. The first question is whether they will announce a new plan to support the oil price. If they do, the second question is whether they will stick to it. 

Technically, a plan is already in place. In...

Stiff sentences for bank fraud capture Italy’s sour public mood

The Economist - Thu, 11/14/2019 - 16:01

IN THE VAULTS of Monte dei Paschi di Siena is a torn and yellowing sheet of paper: a death sentence from the 15th century, handed down for trying to steal gold from what may be the world’s oldest bank. Monte Paschi’s archivists now have another historic sentence for their files. On November 8th a court in Milan convicted former executives for hiding vast losses from derivatives transactions a decade ago, in collusion with bankers from Deutsche Bank and Nomura. It was one of the harshest penalties imposed anywhere relating to the financial crisis.

Thirteen people were convicted, including Michele Faissola, Deutsche Bank’s former global head of rates, and Sadeq Sayeed, Nomura’s former chief executive for Europe. Giuseppe Mussari, Monte Paschi’s former chairman, received the heaviest sentence, of seven years and six months. Deutsche Bank and Nomura were fined a total of nearly €160m ($176m). Monte Paschi, which was nationalised in 2017 as its losses spiralled, had already settled.

Judges ruled that the former bankers had hidden hundreds of millions of euros at Monte Paschi between 2008 and 2012 using a “two-leg” bet on interest rates. This flattered its current accounting position, but led to several years of losses as it repaid Deutsche and Nomura. Deutsche is reviewing the ruling; Nomura has said it is considering an...

Cost-benefit analyses offend against the notion that life is priceless

The Economist - Thu, 11/14/2019 - 16:01

THE AIRLESS nooks under a man’s foreskin are a cosy spot for microbes. These can inflame the surrounding skin, helping viruses such as HIV to spread. In places where the disease is common and treatment is patchy, removing foreskins can be a cost-effective way to fight it. In parts of Africa, the benefits of circumcising adolescents can outweigh the costs by about 10 to 1, according to the Copenhagen Consensus Centre (CCC), a think-tank. The ratio rises above 40 to 1 in the worst-hit countries.

Circumcision is not an obvious vote-winner. But policymakers cannot afford to be squeamish in the fight against one of history’s greatest killers. Nor should they flinch at another off-putting, but essential, step in the war against poverty and disease: putting a dollar value on human life. Without one, it is impossible to compare efforts to vanquish HIV, malaria or diarrhoea with other outlays, such as building railways, electrifying villages, conserving mangroves or educating preschoolers. Quantifying the worth of all these good causes is the aim of a new CCC report evaluating 27 policies to promote African health and prosperity.

Such exercises often get a bad press because they offend against the deeply held feeling that life is priceless. This sacred principle is constantly breached in practice, of course: whenever a...

The improved mood in financial markets

The Economist - Thu, 11/14/2019 - 16:01

IT HAS BEEN a year of mood swings in financial markets. In the spring and summer, anxious investors piled into the safety of government bonds, driving yields down sharply. Yields have recovered in recent weeks (see chart 1). This is not the only sign that investor sentiment has improved.

In general, safe assets have been sold in favour of cyclical ones. The Australian dollar, a cyclical currency, is up against the yen, a haven for the fearful. Something similar is happening in commodity markets, where the price of copper, a barometer of global industry, has risen against the price of gold (see chart 2).

Equity prices in America have reached a new peak. But what is more striking is the performance of cyclical stocks relative to defensive ones. Within America’s market the prices of industrial stocks, which do well in business-cycle upswings, have risen relative to the prices of utility stocks, a safer bet in hard times. In Europe the stocks of financial firms, the fortunes of which are tied to the business cycle, have risen relative to those of firms that make consumer staples—food, beverages, household goods and so on—which are more resilient in bad times (see chart 3).

Investors have also begun to embrace assets at the riskier end of the spectrum. A host of emerging-market currencies have gained against the...

Some Chinese firms turn out to have lied about their state pedigree

The Economist - Thu, 11/14/2019 - 16:01

IT CERTAINLY SOUNDS pretty powerful: China Nuclear Engineering Construction Group. Once controlled by the People’s Liberation Army, it is now, it says, part of a “central state-owned enterprise (SOE)”, an elite class of firms belonging to the Chinese government. Its website is full of pictures of its executives signing deals around the country. Like any good state-run giant, it is politically correct, its statements echoing Communist Party slogans. There is just one snag: China Nuclear Engineering Construction Group is not a central SOE.

As China’s economy slows, defaults have risen sharply. Such failures, though painful, separate strong companies from also-rans, a process other countries know well. In China there is an extra wrinkle: the downturn is also exposing fake SOEs. These are companies that misled creditors about their state connections to suggest they would be supported if they ran into trouble. But when trouble arises, the government is nowhere to be found.

Last month Huarong, a firm that handles non-performing loans, put 610m yuan ($87m) of China Nuclear Engineering Construction’s assets up for sale, consisting of property in the province of Anhui. Despite its name, China Nuclear focused on property, like several other fake SOEs. It also benefited from confusion with a real SOE, China Nuclear Engineering and...

How Jim Simons became the most successful investor of all time

The Economist - Thu, 11/14/2019 - 16:01

The Man Who Solved The Market.  Gregory Zuckerman. Penguin Random House; 359 pages; $30

THE BEST investors’ strategies often sound simple. “Whether it’s socks or stocks, I like buying quality merchandise when it’s marked down,” says Warren Buffett. Betting big on the fallout from epoch-making events, like the fall of the Berlin Wall, is George Soros’s preferred tactic. Jim Simons, the founder of Renaissance Technologies, a hedge fund, spots patterns.

Mr Simons is less famous than Mr Soros or Mr Buffett, but no less successful. He founded Renaissance in 1982, aged 44, after a successful career in mathematics and code-breaking. Its flagship Medallion fund has earned $100bn in trading profits since 1988, mostly for its employees. The average annual return of 66% before fees makes Mr Simons one of the most successful investors of all time. He is now worth $21bn.

A new book, “The Man Who Solved the Market” by Gregory Zuckerman of the Wall Street Journal, asks how he did it. It is a compelling read. Mr Simons started investing in 1978 by looking for patterns in currencies. He had early successes with simple “reversion to the mean” strategies, buying when a currency fell far enough below its recent average. A decade later René Carmona, another mathematician,...

Revisiting the euro’s north-south rift

The Economist - Thu, 11/07/2019 - 16:08

SINCE THE euro zone was first engulfed by a sovereign-debt crisis a decade ago, northern member states have dished out plenty of strictures. “Greece, but also Spain and Portugal, have to understand that hard work...comes before the siesta,” advised Bild, a German tabloid, in 2015. Two years later, even as the crisis receded, Jeroen Dijsselbloem, then the Dutch finance minister, told southerners: “You cannot spend all the money on drinks and women and then ask for help.”

Northerners’ constant fear of underwriting southern irresponsibility has led politicians from Amsterdam to Helsinki to put the brake on banking reforms and fiscal integration across the zone. It has caused numerous fights over monetary policy, the latest of which is in full swing. On November 1st the European Central Bank (ECB) resumed quantitative easing (QE), the purchase of bonds using newly created money. The decision to do so, made in September, was roundly attacked by newspapers—and even former and current central bankers—in northern countries including Germany and the Netherlands. The complaints reflect savers’ dread of negative interest rates and a suspicion that easing lets indebted southern countries off the hook. Together this can make monetary policy seem like a source of transfers.

In reality, the matter of whether...

Belligerent unions are a sign of economic health

The Economist - Thu, 11/07/2019 - 16:08

THE DISSONANCE could hardly have been more apparent. America’s most recent employment figures captured a jobs market in fine fettle: firms added 128,000 new workers in October, while unemployment held near historically low levels and wages rose at a respectable clip. The data would probably have looked better, however, had they not been depressed by a costly labour dispute, only recently ended, at General Motors (GM). Workers around America are showing their restlessness; members of the Chicago Teachers’ Union returned to work on November 1st, after striking to demand higher pay and more investment per student. The unrest may seem odd given the robust state of the labour market. In fact it is neither a bad omen nor entirely unwelcome.

In their book on organised labour, “What Do Unions Do?”, Richard Freeman and James Medoff argue that unions play two principal economic roles. They provide workers with a voice; through a union frustrated workers, who might otherwise simply quit, can communicate their dissatisfaction to the firm. Communication can raise efficiency by boosting morale, and by helping firms to retain workers and identify and fix problems. But unions also function as monopoly providers of labour. By controlling labour supply they are able to extract rents—and thus raise members’ compensation—reducing economic efficiency....

What is the illiquidity premium?

The Economist - Thu, 11/07/2019 - 16:08

IMAGINE TWO bonds listed on different exchanges that are otherwise identical. The risk-free rate of return is 2%. Investors hold bonds for an average of one year. A central bank acts as market-maker, supplying cash on demand for bonds. To cover its costs, the price the central bank pays (the bid) is a bit below the fair value of a bond, which is the price it requires buyers to pay for it (the ask). The bid-ask spread is the cost of trading. For A-bonds it is 1%. For B-bonds, which are listed on an inefficient exchange that charges higher fees, it is 4%.

What is the yield on each bond? It varies with trading costs. Investors on average make one round-trip sale-and-purchase a year. So the yield they demand on A-bonds is 3%. That includes the risk-free rate of 2% plus 1% compensation for trading costs. By the same logic, the yield on B-bonds is 6%. The extra 3% return required on the harder-to-trade security is known as the illiquidity premium.

Illiquidity matters less if investors have longer horizons. A pioneering paper by Yakov Amihud and Haim Mendelson, published in 1986, posits that investors with the shortest horizons hold securities with the lowest trading costs; and bonds that are relatively illiquid are held by long-term investors, who can spread the higher trading costs over a longer holding period. In principle...

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