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Updated: 15 min 34 sec ago

Revisiting the euro’s north-south rift

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

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?

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...

Mexico’s radical president serves up economic mediocrity

Thu, 11/07/2019 - 16:08

MEXICAN PRESIDENTS tend not to get the economy off to a flying start when they first take office. The past six leaders saw the economy shrink by an average of 0.4% during their first year, but went on to enjoy growth of 3.5% in their sixth and final one (see chart). So likely are governments to enrich their allies at the expense of everyone else that each transfer of power causes investors to hang back until they know where they stand. So it may not be a shock that Mexico will barely grow in 2019, the first year of Andrés Manuel López Obrador’s presidency. But economists worry that the malaise might linger this time.

Mr López Obrador rode to power on the back of popular outrage against the status quo. The left-leaning populist wants to centralise power, boost the scope of the state and balance the books—all while hitting annual GDP growth of 4%, “double the growth achieved in the neoliberal period”.

The list of headaches is long. Consumer confidence, which rocketed after Mr López Obrador’s inauguration, has slumped. Manufacturers are struggling: in the past year capital-goods imports are down by 16% in dollar terms, the biggest drop since the global financial crisis. The pace of formal job creation has decelerated over the past year. Economists have repeatedly slashed growth forecasts.


Distressed debt funds are waiting for a downturn

Thu, 11/07/2019 - 16:08

ON NOVEMBER 4TH the share price of Kier Group, a troubled British builder, fell by nearly 10% on reports that banks were trying to offload its debt at a steep discount. The rumour remains unconfirmed—sources close to the firm and one of its biggest lenders dispute the claim—but investors may have felt a sense of déjà vu all the same. After the sudden downfall of Carillion and Interserve, Kier is Britain’s third construction giant to face a battle for survival in less than two years. And each time the groups’ fortunes have worsened, hedge funds eager to snap up their debt at bargain prices have begun to circle.

Funds that buy “distressed” debt, which typically yields ten percentage points or more over Treasuries, are becoming familiar villains. They pounced on Thomas Cook, a travel group, and PG&E, a Californian utility, shortly before they went bust this year. They tend to circle around ailing oil firms and shops disrupted by e-commerce, notes Christine Farquhar of Cambridge Associates, an investment firm. And they snap up portfolios of dud loans from banks. If their target ends up recovering, they pocket big profits. If it does not, they often gain regardless, as they are usually first in line for liquidation proceeds.

Yet distressed specialists are frustrated. Convinced that a recession was just around the corner...

Litigation finance faces ethical quandaries

Thu, 11/07/2019 - 16:08

FROM A FINANCIAL perspective, a civil lawsuit is rather like a derivatives contract. Its value to a claimant comes from the performance of an underlying asset—litigation—with an uncertain, potentially lucrative outcome. No surprise, then, that some see the allure of funding legal expenses upfront in exchange for a share of the proceeds if the case is won or settled. Payouts are uncorrelated with other markets, so investors can use them to diversify. The complexity of the asset makes it hard to price, which offers room for shrewd calculation. Throw in reports of fat returns from third-party litigation-finance (TPLF) firms and it is easy to see why the industry is growing strongly. A survey by Westfleet Advisors, a litigation-finance broker, finds that commercial cases in America attracted $2.3bn of investment in the year to June.

Speaking at an industry conference in New York in September, David Perla of Burford Capital, a litigation funder that is listed in London, trumpeted his firm’s $2.5bn in assets and $225m in half-year post-tax profits. Michael Nicolas of Longford Capital, a private funder, said that lawyers are now more receptive to TPLF. So too are companies and universities harbouring “monetisable” claims of patent infringement. Boosters champion the industry’s ability to provide capital, share risk and increase access to...

Have billionaires accumulated their wealth illegitimately?

Thu, 11/07/2019 - 16:08

BILLIONAIRES HAVE never exactly been popular with the radical left. But with a member of the nine-zero club sitting in the White House, and a decade of slow growth in living standards, some Democrats have taken to attacking billionaires to draw attention to their argument for root-and-branch economic reform. “Billionaires should not exist,” says Bernie Sanders, a presidential candidate. Plutocrat-bashing has become part of the debate in Britain, too, where an election will be held on December 12th. At the Labour Party’s campaign opener Jeremy Corbyn, its far-left leader, attacked the Duke of Westminster, one of Britain’s wealthiest landowners, and Rupert Murdoch, a media mogul.

Socialists argue that anyone who has become fantastically rich has profited from a rigged system. “Every billionaire is a policy failure,” goes the memorable phrase. To assess this claim The Economist has drawn on data from Forbes, a business magazine, on billionaires in the rich world, updating an index of crony capitalism that we first put together in 2014 (see chart).

In the past decade the wealth of the world’s 2,200-odd plutocrats (which puts them inside the world’s top 0.0001%) has risen much faster than global GDP. Still, most of the world’s billionaire wealth has been earned fair and square...

Financial crime through video games is on the rise

Thu, 11/07/2019 - 16:08

FOR PEOPLE who enjoy being (virtually) shot in the head by foul-mouthed teenagers, Counter-Strike has long led the field. The game, developed by Valve Corporation, pits a team of terrorists against an anti-terrorist commando squad in a fight to the death. Its various iterations have helped make Steam, a digital marketplace for video games also run by Valve, among the most successful in the industry. But Counter-Strike has appealed to more than just twitchy young men of late. On October 28th Valve announced it was stopping the trading between players of “container keys”—an in-game gambling device that players can buy (with real money) to try to win (virtual) rewards such as special weapons or clothing. The firm says “nearly all” of the trades of such keys were “believed to be fraud-sourced”. It is a rare admission of the growing problem of using video games to facilitate financial crime.

The company has released no further details, and did not reply to a request for information from The Economist. But it seems likely that the keys, which were bought with stolen credit cards, were then traded between accounts on Steam’s marketplace. Players cannot withdraw real money from their accounts, but in-game credit can be used to buy new virtual rewards or games. There is a burgeoning market (on third-party websites) for...

China tries to squeeze more out of a small trade deal with America

Thu, 11/07/2019 - 16:08

THE TRADE conflict between China and America has been a clash not just of giant economies but of utterly different public negotiating styles. In one corner are President Donald Trump’s tweets, in which he veers between heaping praise on China and declaring that he has pummelled it. In the other is a Chinese bureaucracy that has stuck doggedly to the same message: tariffs must be removed for the two countries to reach a trade agreement. A mini-deal, hashed out last month, is shaping up to be a mini-test of their contrasting approaches.

The outline of the mini-deal—or, as Mr Trump put it, the “substantial phase-one deal”—seemed clear enough. China would buy American agricultural products, and America would hold back from slapping yet more tariffs on China. With this basic agreement under their belts, the two combatants would move onto weightier topics such as China’s support for its strategic industries. But two problems have since emerged: one predictable, one not.

As was foreseeable at the time, the lack of detail about the mini-truce concealed big differences. Mr Trump said that trade talks had been “a love fest”, and that China would buy $40bn-50bn in farm goods from America, more than double the level before the trade war. But the more he gloated, the more China appears to have seen an opening to push for more....

America and China are sparring over subsidies

Thu, 10/31/2019 - 16:02

AS TRADE TALKS continue between America and China, old fights are rumbling on. On October 28th China asked the World Trade Organisation (WTO) to allow it to retaliate against $2.4bn of imports from America, as part of a long-running dispute over American treatment of Chinese exports. The final sum will be set by an arbitrator, and will be small in the broader context of the two countries’ escalating trade war. But the symbolism will make it sting.

The dispute concerns two of America’s biggest gripes: China’s economic model and the WTO’s inability to constrain it. America accuses China’s government of bloating its private sector with subsidies, which spill over to affect businesses abroad. If state-owned banks make cut-price loans, or state-owned electricity companies sell cheap energy, Chinese exporters have an unfair advantage, it says. By last year America had imposed tariffs on almost 7% of Chinese imports, citing such subsidies and the need to defend itself.

Americans argue that if Chinese state institutions hold a majority stake in a company, this strongly suggests it is a “public body” and therefore capable of giving subsidies. But the WTO’s appellate body has generally disagreed. It has also often backed China’s stance that America’s defensive duties are too harsh.

The United States Trade Representative,...

Why the repo market went awry…

Thu, 10/31/2019 - 16:02

ON SEPTEMBER 17TH, for the first time in a decade, the Federal Reserve intervened in the overnight repurchase, or “repo” market, where banks and hedge funds get short-term funding by swapping $1trn-2trn of Treasuries for cash each day. After the repo rate rose to 10%, the federal-funds rate, at which banks can borrow from each other, climbed above the Fed’s target (see chart). The Fed swooped in, offering $75bn-worth of overnight funding, and both rates came back down. But it has had to keep lending to stop them rising again. During October it said it would lend for longer periods, increased its limit on overnight repo operations to at least $120bn and started buying short-dated Treasuries directly, at a pace of $60bn per month.

The turmoil indicated an unexpected shortage of liquidity in the financial system. Before the financial crisis the Fed had controlled the federal-funds rate using a “corridor”, with a ceiling and floor. Banks could borrow at the ceiling rate, but the floor rate was zero, meaning cash held at the Fed earned nothing. To keep interest rates on-target the Fed used “open-market” operations, swapping Treasuries and cash.


A scholar of inequality ponders the future of capitalism

Thu, 10/31/2019 - 16:02

WHEN COMMUNISM fell, that was supposed to be that. History would continue, but arguments about how to organise society seemed to have been settled. Yet even as capitalism has strengthened its hold on the global economy, history’s verdict has come to seem less final. In a new book, “Capitalism, Alone”, Branko Milanovic of the Stone Centre on Socioeconomic Inequality at the City University of New York argues that this unification of humankind under a single social system lends support to the view of history as a march towards progress. But the belief that liberal capitalism will prove to be the destination has been weakened by financial and political dysfunction in the rich world, and by the rise of China. Its triumph cannot be taken for granted.

Mr Milanovic outlines a taxonomy of capitalisms and traces their evolution from classical capitalism before 1914, through the social-democratic capitalism of the mid-20th century, to “liberal meritocratic capitalism” in much of the rich world, in particular America. He contrasts this with the “political capitalism” found in many emerging countries, with China as the exemplar. These two capitalistic forms now dominate the global landscape. Their co-evolution will shape world history for decades to come.

Liberal meritocratic capitalism is generally associated with liberal political...

As profits dwindle, HSBC plans a radical overhaul

Thu, 10/31/2019 - 16:02

WHEN NOEL QUINN took over as interim chief executive of HSBC from John Flint, ousted by the board in August, analysts expected a change in style. Whereas Mr Flint was seen as a cerebral introvert, Mr Quinn is forthcoming, verging on blunt.

On that front, at least, HSBC’s first quarterly-results announcement on his watch did not disappoint. Although its Asian business “held up well in a challenging environment”, performance in other areas was “not acceptable”, Mr Quinn said on October 28th. Third-quarter net profits, down by 24% on the same period last year, to $3bn, undershot pundits’ forecasts by 14%. Revenues fell by 3.2%, to $13.4bn, missing expectations by 3%. Return on tangible equity (ROTE), its chief measure of profitability, reached 6.4%, compared with analysts’ forecast of 9.5%. Investors agreed with Mr Quinn: the bank’s shares dropped by 4.3% on the news in London. They have fallen by about 11% in the past six months.

HSBC’s woes can be blamed in part on broader conditions: low interest rates, a slowing global economy, business uncertainty in Brexit-hit Britain and trade tensions (HSBC is the world’s largest provider of trade finance). Yet that is hardly likely to reassure investors. Tom Rayner of Numis Securities, a broker, points out that although some of these trends may be reversed, others, such as Brexit...

Capital is flooding into Silicon Valley

Thu, 10/31/2019 - 16:02

DEALMAKERS ARE smooth talkers. They need to be. But which branch of finance has the slickest ones? Consider the polished, public-school manner of the City investment banker—or the high-velocity spiel of the Wall Street bank boss. Both have a strong claim. But the venture capitalists, or VCs, of Silicon Valley have a stronger one. They spend their time either being pitched to by, or pitching on behalf of, entrepreneurs who hope to be the next Zuck or Larry-and-Sergey. Peddlers of such extravagant dreams have to have silver tongues.

They certainly have some catchy phrases. They speak of “vanity metrics” (misleading measures of a startup’s progress); of the importance of “product-market fit” (how well a piece of software meets the customer’s needs); and “deal heat”, the fever that causes investors to overpay. After a while even a normally buttoned-up Buttonwood is asking to “double-click” on a topic when he wants more detail from a voluble VC.

A subject guaranteed to get them talking is the flood of capital into Silicon Valley. In the popular metaphor, the VC business used to consist of a flotilla of small boats fishing in a well-stocked lake. It was all very collegial. Now the lake is an ocean. Trawlers are out there—big institutions, such as sovereign-wealth funds and pension-fund managers, that increasingly invest...

Inflation in Turkey has fallen steeply

Thu, 10/31/2019 - 16:02

TURKEY’S PRESIDENT, Recep Tayyip Erdogan, once called high interest rates “the mother of all evil”. Murat Uysal, its new central-bank governor, must then be close to angelic. Since Mr Erdogan sacked Mr Uysal’s predecessor four months ago for refusing to slash interest rates, he has cut three times, by a cumulative ten percentage points (see chart 1). The latest cut, of 2.5 percentage points on October 24th, was more than double market expectations.

After last year’s aggressive tightening, easing now makes some sense. Inflation is back in single digits, after passing 25% last autumn. The lira has partially recovered from a battering that had pushed domestic prices up. In early October America threatened sanctions in response to Turkey’s offensive in Syria. The lira slumped, but after America brokered a ceasefire deal on October 17th, it steadied again. It strengthened further when Turkey’s and Russia’s presidents signed a similar agreement. That gave the bank room for the most recent cut.


China’s median age will soon overtake America’s

Thu, 10/31/2019 - 16:02

SHORTLY AFTER 9am the neighbourhood care centre for the elderly shuffles to life. One man belts out a folk song. A centenarian sits by his Chinese chessboard, awaiting an opponent. A virtual-reality machine, which lets users experience such exotic adventures as grocery shopping and taking the subway, sits unused in the corner. A bigger attraction is the morning exercise routine—a couple of dozen people limbering up their creaky joints. They are the leading edge of China’s rapid ageing, a trend that is already starting to constrain its economic potential.

Since the care centre opened half a year ago in Changning, in central Shanghai, more than 12,000 elderly people from the area have passed through its doors. The city launched these centres in 2014, combining health clinics, drop-in facilities and old-people’s homes. It plans to have 400 by 2022. “We can’t wait. We’ve got to do everything in our ability to build these now,” says Peng Yanli, a community organiser.


What kind of bank will Wells Fargo be?

Thu, 10/24/2019 - 14:56

WELLS FARGO has reinvented itself before. In a vault beneath the bank’s headquarters in San Francisco is an archive of papers and objects from the 1860s, when the company’s stagecoaches criss-crossed America delivering packages. Advertising posters tout the security of their wagons, thanks to the sharp-shooting skills of the marksmen that accompanied them. As first the railroads, then the telegram and later a government-run delivery service threatened the survival of the firm its bosses adapted, using customers’ trust in their brand to expand their banking business.

Charlie Scharf, who took over as the bank’s chief executive on October 21st, must transform Wells once again. He comes from BNY Mellon, a smaller bank based in New York. It is rare for a giant lender to pick an outsider to run it. The bosses of America’s other largest banks—JPMorgan Chase, Bank of America, Citigroup, Morgan Stanley and Goldman Sachs—are seasoned insiders.

But these are unusual times for Wells. The bank has spent three years trying to cleanse itself of scandal. In 2016 it was revealed that millions of spoof accounts had been opened by more than 5,000 employees. Further infractions involving home and auto loans have since come to light. Regulators have slapped penalties on the bank, the most onerous of which was capping its assets at $1.95trn...

The deep appeal of emerging markets is their lack of surface appeal

Thu, 10/24/2019 - 14:55

BILL HICKS, a much-mourned comedian, would pause in the middle of his act as if a thought had just occurred to him. He would ask that anyone in the audience who worked in advertising or marketing kill themselves. This was the only path to redemption now left open. No one took up his invitation. I know what the marketing people are thinking, he would then say. The anti-marketing dollar, that’s a good market. Look at our research! Bill is smart to tap into it.

Such next-level thinking comes to mind whenever the case for emerging markets is considered. For professional investors, diverting capital from America’s stockmarket to other less-blessed places seems like an invitation to career suicide. The dollar’s continued strength is kryptonite to emerging markets. They feel the damage from the trade war most keenly. Sure, emerging markets look cheap. But there is no law saying they cannot become even cheaper.

Cheapness aside, though, there is another, less appreciated, side to emerging markets. As capital rushes into an ever narrower set of favoured rich-country assets, there is growing anxiety that it might all suddenly unwind. At least emerging markets are an uncrowded trade. This is a paradox that tricksy marketing types should appreciate: the unloved asset class, that’s a good market. You might be wise to tap into it....

Japan’s new investment rules risk scaring off foreign investors

Thu, 10/24/2019 - 14:55

“BUY MY ABENOMICS!”, Shinzo Abe, Japan’s prime minister, pleaded to the New York Stock Exchange in 2013. As he lowered the drawbridge to foreign investors, that pitch seemed to work. Today overseas owners hold 30% of Japan’s TOPIX index of stocks and account for about 70% of the daily turnover on the Tokyo Stock Exchange (TSE). But new rules threaten to reverse these trends. 

A proposed change to the Foreign Exchange and Foreign Trade Act, unveiled on October 8th, will lower the minimum stake foreigners can buy in many listed Japanese companies without prior government approval, from 10% to 1%. Other changes include requiring foreign directors to seek official permission before they sit on the boards of Japanese firms. 

The finance ministry says it wants to protect sensitive sectors such as energy and weapons manufacturing. But analysts warned that the rules could choke off investment. Akira Kiyota, the head of the TSE told the Financial Times they were “absolutely idiotic”. Under fire, the finance ministry clarified on October 18th that foreign “portfolio investors” (such as banks, insurance firms and asset managers) would not need to seek prior approval, as long as they could prove they had no intention “to influence management”. The tweaked legislation was approved by the cabinet and...

The remarkable influence of the World Bank’s business rankings

Thu, 10/24/2019 - 14:55

A CLOTHING WORKSHOP, with just two sewing machines, established long ago on the outskirts of Lima, Peru’s capital city, may be one of the world’s most influential companies, even though it never started operating—and was never intended to do so. The business was conceived as an experiment by Hernando de Soto, a Peruvian economist, who commissioned a team to go through the motions of setting up the firm. Their aim was to find out how long it would take to comply with all the laws and regulations required to start a business. The answer was 289 painstaking days.

The answer now is a mere 26 days, according to the World Bank’s latest report on the ease of doing business around the world. Inspired in part by de Soto’s example, the bank each year asks thousands of lawyers, accountants and other experts how easy it would be for a company to obtain an electricity connection, transfer the title of a warehouse, enforce a debt contract, pay its taxes and so on. Based on the answers, the bank then ranks countries, from New Zealand at the top to Somalia at the bottom.

The report has its critics. Since it ignores infrastructure, price stability, workforce skills and the reliability of suppliers, among other things, it is not really a summary measure of the ease of doing business in a country. It is instead a snapshot of the cost of...