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Germany’s long expansion comes under threat

Thu, 02/07/2019 - 10:18

GERMANY’S EXPORTING prowess is so impressive that other countries seek to import even its policies. France recently passed labour reforms inspired by its neighbour to the east. British politicians periodically try to copy its vocational-training system. Governments far and near have sought to emulate the Mittelstand, its small and mid-size producers. Germany’s knack for producing goods desired by emerging economies, notably a booming China, helped it recover rapidly from the financial crisis of 2007-08, and cushioned the impact of the sovereign-debt crisis that subsequently engulfed the euro zone.

Now Germany is propelling the currency bloc into a slowdown. The economy shrank in the third quarter of 2018 and probably grew only slightly in the fourth. Over the year as a whole, GDP grew by 1.5%, down from 2.2% in 2017 and below the euro-zone average (see chart 1). New emissions tests...

A commission of inquiry reaches a damning verdict on Australia’s banks

Wed, 02/06/2019 - 15:45

IF A HEALTHY banking system is dull, then Australia’s must be sick to the core. A royal commission with a broad remit to investigate abuses by the country’s financial institutions has found many troubling practices. Hearings revealed that for years banks had hidden fees, charged money for non-existent services and docked charges from the dead. Financial advisers earned bonuses for channelling clients’ cash towards underperforming funds. Insurance companies flogged junk schemes to the poor or mentally disabled.

Australia’s four biggest lenders saw their market capitalisation fall by an average of 16.3% while the commission was sitting, knocking A$66bn ($47.1bn) off their combined value. In April the country’s biggest asset manager, AMP, sacked its chief executive and chairman after the inquiry heard that it had not only charged customers for advice that was never provided, but had lied to the regulators about it....

Bill Gross, the king of the bond market, abdicates

Tue, 02/05/2019 - 19:57

OUTSIZE RETURNS are hard to come by in the bond market: the approach pioneered by Jack Bogle at Vanguard of matching a benchmark while minimising transaction fees is tough to beat. There was one person, however, that even Vanguard’s fixed-income team considered in a class of his own and thus worth paying for: Bill Gross, who co-founded Pacific Investment Management Company (PIMCO) in 1971 after a conventional career in finance and risk, plus a brief professional foray onto the blackjack tables of Las Vegas. On February 4th Mr Gross and Janus Henderson, his employer for the past few years, announced that he was retiring.

For decades Mr Gross displayed extraordinary acumen, not only in evaluating securities but also in structuring the duration, or time-frame, of his portfolio. He displayed uncanny judgment about when to push maturities just a bit longer or shorter than average. His calls were amplified by his...

A bold new plan to tackle climate change ignores economic orthodoxy

Tue, 02/05/2019 - 17:42

AS DEALS GO, the New one was a big one. Franklin Roosevelt’s plan to yank America out of depression permanently altered the contours of the country’s economy and politics. Proponents of a “Green New Deal” harbour similar ambitions. Though still nebulous the proposal, championed most loudly by Alexandria Ocasio-Cortez, a new congresswoman from New York, has been met with surprising enthusiasm in Washington. It is an outright rejection of the orthodox economic approach to climate change.

In economics, climate change is a big but straightforward example of a market failure, with a correspondingly straightforward solution. People take environmentally harmful decisions because the private benefits of doing so (using a car to get to work, say) outweigh the private costs (the price of the petrol to run the car). But emission-producing activities also impose social costs—deaths from pollution and collisions, the contribution...

Puerto Rico’s biggest bank came out of Hurricane Maria stronger

Thu, 01/31/2019 - 15:43

PUERTO RICO was never the most financially stable of places. After years of trouble its government defaulted in 2016. Then, in 2017, Hurricane Maria roared in. The island took close to a year to restore electricity fully, and financial restructuring continues. Manufacturers decamped during the power cuts; many did not return. Banco Popular, the biggest financial institution, which had already been buffeted by a wave of bad loans, was hit by another. Its failure would have been no surprise.

Prepare to be astonished, then: Popular is in pretty decent shape. Part of that is due to the island’s tentative recovery. Sales of cement and cars have been strong; tourism is starting to pick up. But even so, Popular’s performance is striking. The KBW index, a broad measure of American banking stocks, has fallen by 16% in the past year; Popular’s shares are up by a third. Over the past five years the KBW index rose by 46%; Popular’s shares...

Conflicts in the credit-derivatives market threaten to undermine it

Thu, 01/31/2019 - 15:43

SHAKESPEARE WAS a fan of the quibble. His plots often hinge on the gap between word and intended meaning. Macbeth was supposed to be invincible because he could be harmed by “none of woman born”—but his killer, Macduff, was delivered by Caesarean section. In “The Merchant of Venice” Portia saves Antonio by arguing that though he agreed to forfeit a pound of flesh to Shylock if he defaulted on a loan, he did not agree to lose blood.

Traders in credit-derivative markets are keen on quibbles, too. Credit-default swaps (CDSs) are insurance-like derivatives designed to compensate lenders when a company goes bust. A simple enough aim, you might think, but there are plenty of devilish details. A company can go bust in many ways: it can close and have its assets sold off, or restructure its debt and keep operating. And CDS contracts pay out the difference between a bond’s face value and the price of the cheapest bond available, even though the underlying...

Illicit financial flows are hard to stop

Thu, 01/31/2019 - 15:43

WHEN FOREIGN aid enters developing countries, it is welcomed with handshakes and ribbon-cutting. Private money, by contrast, is sometimes smuggled across borders or siphoned into offshore bank accounts. Everyone agrees that such “illicit financial flows” are a problem. A report published on January 28th by Global Financial Integrity (GFI), a campaign group, estimates that illicit flows to and from developing countries are worth more than a fifth of their total trade with the rich world.

Governments have pledged to plug the leaks, including as part of the UN’s Sustainable Development Goals. If only they could reach agreement on what they are talking about. A few rich countries, notably America, complain that illicit flows are not properly defined. Statisticians are still puzzling over how they can be accurately measured.

Obviously, gun-running and drug-trafficking should count; in 2011 the UN estimated that financial flows linked to transnational organised crime were worth 1.5% of global GDP. Bribes, and the proceeds of unregistered trade in legal goods, such as cigarettes, probably should, too. But broader definitions also fold in tax avoidance, which may not be illegal. The result is hopelessly vague, diverting attention from dirty money to smear legitimate businesses, argues Maya Forstater of the Centre for Global...

Value investing is long on virtue but has been short on reward

Thu, 01/31/2019 - 15:43

IN A COMEDY sketch from the 1980s, Rowan Atkinson plays the devil as a cross between a package-holiday guide and a louche English bureaucrat. Dressed in a smoking jacket, he welcomes the damned to Hell and, consulting his clipboard, sorts them into groups. Lawyers? Join the thieves and murderers over there. The French? Come down here with the Germans. Atheists? You must be feeling pretty silly. And finally, Christians? I’m sorry, your faith was an error.

Even if they are not confronted by hard evidence, everyone is occasionally troubled by the thought that their beliefs are misplaced. A bad run of stockmarket returns is such a test of faith. Investors who favour “value” stocks—those with a low price relative to the book value of a firm’s assets—have had to wrestle more than most with doubt. If you buy value, and are patient, your reward should be superior returns. But for much of the past decade, value has seemed a...

An overbanked region sees some welcome consolidation

Thu, 01/31/2019 - 15:43

WHEN YOU have 60 banks in a country of just 9.5m people, there is much to be said for merging three at a time. On January 29th Abu Dhabi Commercial Bank (ADCB), the third-biggest bank by assets in the United Arab Emirates (UAE), agreed to buy eighth-ranked Union National Bank in an all-share deal. The enlarged ADCB will then swallow Al Hilal Bank, a smaller, Islamic bank. All three are controlled by Abu Dhabi’s government, which will own 60.2% of the new entity.

The deal is the latest of several tie-ups, actual or mooted, among banks in the Gulf. On January 24th Kuwait Finance House, that country’s second-biggest bank, announced “tentative” agreement on takeover terms with Ahli United Bank, of Bahrain. Saudi British Bank and Alawwal Bank are joining forces to form Saudi Arabia’s third-largest lender. The kingdom’s number one, National Commercial Bank, is talking to Riyad Bank, the current number four. And in 2017...

Italy’s slump reflects trouble both at home and abroad

Thu, 01/31/2019 - 11:03

ITALY BOASTS no glittering economic record. GDP growth has trailed the euro-area average every year since 1999. Despite a decent showing in 2016-17, the economy has yet to regain fully the output lost during the global crisis a decade ago and a domestic banking scare a few years later.

Now even its modest recovery seems to have gone into reverse. Figures published on January 31st showed that Italy slipped into recession in the second half of 2018. The economy shrank by 0.2% in the final quarter of 2018, its second consecutive contraction (see chart). The causes are both domestic and external. They seem likely to depress the economy this year, too, and to worsen an already fraught fiscal position.

The euro zone—notably Germany—has lost momentum as global trade has slowed. Italy has not been immune. Exports rose by nearly 6% in 2017, but Loredana Federico of UniCredit, a bank, reckons they probably grew by just 1% last year. Giada Giani...

A new initiative aims to modernise global trading rules

Wed, 01/30/2019 - 18:46

“SATISFACTION GUARANTEED!” promises the seller of “The Law and Policy of the World Trade Organisation” (WTO). The magic of e-commerce means that the doorstopper can be exported from America to Tajikistan for a cool $35.95 (plus shipping). A new initiative on digital trade at the WTO strives to add to the laws and policies described within its pages. But far from increasing general satisfaction, this plan is controversial.

At first glance, it is hard to see why. On January 25th representatives of 76 WTO members gathered at the annual shindig in Davos announced plans to negotiate new rules covering “trade-related aspects of electronic commerce”. Compared with the trade talks between America and China that restarted this week in Washington, this venture seems positively collegial. It makes sense: trade rules were written when cloud computing was the stuff of science fiction. What better way to demonstrate the value of the WTO, just as President Donald Trump is busy undermining it?

But a closer look reveals conflict. Though the 76 members account for 90% of global trade, they are a minority of WTO members. Many developing countries claim that tighter e-commerce rules would tie national regulators’ hands and that the issue is a distraction from others they care about more, such as limiting rich countries’ agricultural...

Hyperinflations can end quickly, given the right sort of regime change

Tue, 01/29/2019 - 17:39

BANKNOTES USED as toilet paper. Wheelbarrows of cash exchanged for a loaf of bread. Prices in supermarkets revised upwards each hour. These vignettes of hyperinflation would be funny if they did not cause such hardship. This is now Venezuela’s situation, in what may be the final days of the ill-starred regime of Nicolás Maduro. An estimate by Steve Hanke of Johns Hopkins University put the country’s inflation rate last year at 100,000%, with prices doubling roughly once a month. The IMF reckons that in 2019 it may reach 10,000,000%.

Hyperinflations are not an exclusively modern problem. Rome suffered one under the emperor Diocletian. But the spread of fiat currencies, backed by the credibility of a government rather than a physical commodity such as gold, has made them more common. They came in devastating bursts over the past century: in the aftermath of the first and second world wars, during the post-Soviet transition from communism to capitalism, and more recently in misgoverned poor countries, mostly in Africa and Latin America. They are not cases of garden-variety inflation run amok. Rather, they demonstrate a catastrophic breakdown in a state’s capacity to govern. In a narrow sense, they are a monetary phenomenon, with printing presses running nonstop. Yet the important question for economists, and for those trying to end them...

Australia has dodged many banana skins. Is it about to come a cropper?

Thu, 01/24/2019 - 15:46

THERE ARE two ways to film the banana-skin joke, said Charlie Chaplin. The first begins with a wide shot of a man walking down Fifth Avenue. Cut to the banana skin on the pavement. Go to a close-up as foot meets peel. Then pan out to reveal the man landing on his backside. Ha ha ha. The second version is like the first except in this one the man spots the banana skin and carefully sidesteps it. Blind to other hazards, he smiles to the camera—and immediately falls down an open manhole.

The second version is funnier, perhaps because it carries a deeper truth: a mishap avoided can lead to a greater calamity down the road. This seems to be a pattern in financial affairs. Japan dodged the banana skin of America’s 1987 stockmarket crash, only to disappear down a manhole a few years later. Emerging Asia brushed aside the Mexican crisis but imploded later on. Britain sailed through the dotcom bust in the early noughties, but...

Cleaning up Italy’s banks is proving slow and painful

Thu, 01/24/2019 - 15:46

Still standing

“THE BOILS that had to burst have burst,” says Mario Deaglio, an economist at the University of Turin, of Italy’s banks. The latest carbuncle to come to a head is Banca Carige, which was put into temporary administration by the European Central Bank (ECB) on January 2nd—the first time the euro-zone regulator has exercised this power. The move followed a shareholders’ meeting in December that failed to approve the first tranche of a €400m ($455m) capital increase.

The ECB appointed three administrators, including Carige’s former chief executive and chairman, giving them three months to reduce the €3bn stock of bad loans and arrange a merger. Italy’s government issued a decree to guarantee the bank’s bonds for up to €3bn, and to support a precautionary recapitalisation, if requested. On January 18th Banca Carige said it would issue government-backed bonds to the tune of €2bn, and perhaps a...

The market for cyber-insurance is growing

Thu, 01/24/2019 - 15:46

IT SOUNDS AS if it was named by a seven-year-old boy and looks like a film set. Housed in a sleek black truck, IBM’s “X-Force Command Cyber Tactical Operations Centre” travels from city to city, simulating the experience of falling victim to a cyber-attack. Rows of desks sport monitors and keyboards in a room dominated by three giant video-screens. A control room houses server equipment that allows IBM’s staff to simulate a corporate network—and then throw all manner of digital mischief at it. Teenagers “understand what’s going on straight away”, says Caleb Barlow, who runs the show. Board members at big companies enjoy a visit, too: “It’s so different from what they usually do.”

But their interest is not merely recreational. Companies are increasingly worried about the threats lurking in their computer systems. A survey in 2018 by KPMG and Harvey Nash, a firm of headhunters, found that only a fifth of IT bosses...

Efforts to fix the market in auditing rumble on

Thu, 01/24/2019 - 15:46

AUDITORS ARE supposed to provide an independent view of company accounts. But regulators fear that the relationship between auditors and those they audit can become too cosy—which is why the European Union has decided that, from 2020, companies will have to switch auditor at least once every 20 years. Last week the Financial Reporting Council (FRC), a British regulator, sent a letter to audit firms warning them away from “rotation in form but not in substance”.

That was aimed at subsidiaries of American banks. The FRC wants to deter Goldman Sachs and PwC, the auditor it has used since 1926, from seeking to satisfy the new rules by hiring a smaller auditor for the Wall Street firm’s British subsidiary while retaining PwC for the global business.

The spat is a consequence of flaws in the audit market. It is dominated by four global networks: PwC, Deloitte, KPMG and EY, which also have consultancy arms and...

Investors fear that the unwinding of QE is causing market turbulence

Thu, 01/24/2019 - 15:46

AS DULL AS “watching paint dry”. That was how Janet Yellen, the former head of the Federal Reserve, described plans for a gradual unwinding of its $4.5trn balance-sheet announced in September 2017. The Fed’s stock of assets had swelled during the previous decade as it engaged in “quantitative easing” (QE), seeking to ease the pernicious effects of the global financial crisis. Now that the economy had recovered, it planned to shrink its balance-sheet again.

The plan was to set a path and proceed on autopilot. This, it was hoped, would avoid the pace of unwinding being taken as a signal of the direction of interest rates. It would start slowly, just $10bn a month from October 2017, and smoothly pick up pace. By October 2018 it had quickened, as planned, to $50bn.

That coincided with the start of a bout of market turbulence. The S&P 500 index of leading shares fell by 14.0% in the final three months of...

LIBOR’s administrator proposes an alternative to the doomed rate

Thu, 01/24/2019 - 10:03

IN THE FINANCIAL world, LIBOR is a staggeringly important number. The London Interbank Offered Rate—supposedly the rate at which banks can borrow unsecured from one another—is the benchmark for interest rates on around $260trn-worth of derivatives, loans and more. Over $200trn-worth is in dollars. But the number’s number is up. An ever-thinner underlying market and a rate-fixing scandal have prompted regulators to seek replacements. Britain’s Financial Conduct Authority has told banks that they need no longer supply estimates of their borrowing costs, on which LIBOR is based, after the end of 2021. Regulators everywhere would like markets to switch to overnight interest rates.

In a paper published on January 24th, ICE Benchmark Administration (IBA), which has produced LIBOR since 2014, says that overnight rates are widely accepted to be well suited to derivatives, which make up the vast bulk of LIBOR-pegged products....

Headlines about China’s weak growth are somewhat misleading

Wed, 01/23/2019 - 15:50

AMERICA’S PRESIDENT knows a catchy number when he sees one. Like much of the world’s media, Donald Trump tweeted this week that China’s growth in 2018 was its slowest in nearly three decades. This, he said, ought to compel it to make a “Real Deal” on trade with America. China’s growth of 6.6% last year was indeed the weakest since 1990, and the country does want to end the trade war. But a closer look at the data shows why its leaders are less panicked than Mr Trump might think.

First, the sheer size of its economy means that China’s growth last year generated a record amount of new production. Nominal GDP increased by 8trn yuan ($1.2trn), well above the 5.1trn yuan added in 2007, when it notched up 14.2%, its fastest growth in recent decades. The point is simple: China is now growing from a much larger base. But this was overlooked in the flurry of headlines about its slowdown.

The changing nature of China’s growth also...

The euro area is back on the brink of recession

Tue, 01/22/2019 - 17:19

IT BEGAN AS a joke: the Twitter hashtag #euroboom tacked on to news of any sign, no matter how faint, of a euro-area recovery. By 2017, when French, German and even Spanish GDP grew by more than 2%, it seemed to describe a real phenomenon. Alas, all too quickly #euroboom has turned to #eurogloom. GDP data scheduled for release later this month are likely to confirm that in the final three months of 2018 Italy’s economy contracted for a second consecutive quarter, satisfying one of the technical definitions of a recession. Germany appears to have escaped recession, but only just. The euro area, formed in January 1999, may pass its anniversary on the brink of another downturn.

The euro has been an economic fiasco. GDP growth in the euro area has lagged behind that in other advanced economies, and in the European Union as a whole, throughout its life—before the financial crisis, during...