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Finance and economics
Updated: 1 hour 29 min ago

Why yields are the best guide to future stockmarket returns

Thu, 09/05/2019 - 14:46

IN 2011 JOHN COCHRANE, a professor at the University of Chicago’s Booth School of Business, gave a presidential address on “Discount Rates” to the American Finance Association. It was published as a paper a few months later. In a sweeping take, Mr Cochrane set out how academics’ understanding of the way asset prices are determined has shifted over the past half-century. Many papers are described as “landmark”; this one has a better claim to the label than most.

His opening line (“Asset prices should equal expected discounted cash flows”) indicated that the basic premise has not changed. But plenty has. In the 1970s the focus of academic finance was on the “expected” part of that equation—the efficiency with which markets priced in any new information relevant to future cash flows. The emphasis has shifted. The “discounted” part, or the risk preferences of investors, has become the main organising principle for research, argued Mr Cochrane.

The old-school view was that when stock prices are high relative to earnings or dividends (ie, yields are low), it implies these cash flows are expected to grow quickly in future. The new school says it is changes in risk appetite—the discount rate that investors apply to future earnings—that explains much of the variation in asset prices. If prices are high and yields are low, that...

In its dying days, Mauricio Macri’s government emulates its opponents

Thu, 09/05/2019 - 09:18

ARGENTINA WAS not invited to the Bretton Woods conference in 1944 that created the IMF, and it did not join until 1956. But it has been making its presence felt ever since. At the end of August a team from the IMF visited Buenos Aires to assess the lie of the land before deciding whether to give Argentina’s government, led by Mauricio Macri, any more of the record $57bn loan (worth over 10% of Argentina’s 2018 GDP) agreed last year. But as the team left town, the landscape shifted.

Mr Macri’s government said it would delay $7bn-worth of repayments on short-term bills held by institutional investors and seek a rescheduling of over $50bn of longer-term debt. It would also request new, extended loans from the IMF to help Argentina repay the money it already owes them. As the markets digested the news, the ground moved again. On September 1st the government imposed currency controls, preventing Argentines from buying more than $10,000 a month, forcing exporters to convert their earnings into pesos, and placing new restrictions on companies’ ability to buy foreign exchange.

“This is not a port we imagined we would reach,” said Hernán Lacunza, Mr Macri’s new finance minister. The president had, after all, cast off in precisely the opposite direction after coming to power in December 2015, seeking to remove many of the...

Martin Weitzman died on August 27th

Wed, 09/04/2019 - 18:38

MARTIN WEITZMAN, one of his colleagues observed last year, was not an economist you would expect to encounter on the 7am plane from Boston to Washington. That was not because the retired Harvard University professor, who died on August 27th, lacked influence. On the contrary, his research was cited by policymakers around the world. Nor was it because he objected to flying, although he might have done on the basis of his field, environmental economics. It was because he was a recluse who, according to many who knew him, preferred thinking in his study to being with his friends, let alone with politicians. Making intellectual advances was the most important thing.

But what he made of his time at his desk. He was of a rare breed: a theorist capable of brilliant abstract reasoning whose work was nevertheless squarely relevant to essential—and increasingly pressing—policy choices. In 1974, early in his career, he wrote a paper that became a foundation stone of every course on public economics. It posed the question: how should regulators rein in pollution? Should they issue (tradable) pollution permits to firms, thereby picking a quantity? Or should they tax polluters, thereby picking a price?

Two sides of the same coin, went existing thinking, which assumed perfect knowledge on the part of bureaucrats. But Mr Weitzman...

After three Chinese banks are bailed out, how many more are at risk?

Wed, 09/04/2019 - 16:02

WORKING AT Hengfeng Bank, an embattled Chinese lender, requires a thick skin these days. On August 30th the bank’s Communist Party committee summoned its members, including top executives, for a self-criticism session, of the sort common in the Maoist era. “No one talked about their achievements. They talked only of their shortcomings and problems. They pointed the knife blade at themselves,” the bank reported afterwards. “Blushing and sweating, they expelled their poison.”

The revival of self-criticism under Xi Jinping, China’s president, has raised alarm about the direction in which he is steering the country. Other banks have also conducted similar sessions, a testament to Mr Xi’s assertion of party control over the economy. But in the case of Hengfeng, ravaged by corruption scandals and bailed out last month by the government, the sight of its employees examining their misdeeds was, in a way, reassuring. It suggests that officials are getting a handle on one of the worst actors in the banking system, even if their techniques sometimes owe more to Lenin than to Dodd or Frank.

The question now is how many more Hengfengs there are. It was the third bank to be rescued in the space of three months. In May regulators took over Baoshang Bank in Inner Mongolia. In July Industrial and Commercial Bank of China (ICBC), a state...

A Netflix documentary provokes reflection in China

Thu, 08/29/2019 - 14:45

THE COMMENTS came in thick and fast on Douban, a social network popular with film buffs and bookworms. More appeared on Weibo, a microblogging website, where the hashtag #AmericanFactory has gained more than 16m views. The documentary of that name, by a film-making couple from Ohio, was released on August 21st on Netflix. The American firm’s streaming service is not available in China, but pirated copies of the film have proliferated. Strikingly, it has drawn praise—even as the Sino-American trade war stokes nationalist feelings within China.

That reception is partly a testament to the faultlessly balanced take of “American Factory”, shaped by 1,200 hours of rare footage. Much was shot inside a plant in Dayton, Ohio, which was taken over in 2014 by Fuyao, a Chinese glass-making giant that supplies the global car industry. In 2008 General Motors had closed its complex there, so for jobless local people Fuyao’s arrival was a miracle. Before long, however, Stakhanovite bosses clashed with a restive and outspoken factory floor. The film is a parable of modern manufacturing, showing the strengths and weaknesses of each country. For Chinese viewers, the failings of theirs hit home.

“It was hard to watch,” wrote a user on Douban. “Who does not know that Chinese efficiency is driven by depriving workers living at the bottom of...

The Pfandbrief, a fixture of German finance, turns 250

Thu, 08/29/2019 - 14:45

IN 1769 THE noble landowners of Silesia—then in Prussia, now in Poland—were short of cash. War and plummeting farm output had left their mark. On August 29th the king stepped in. Frederick the Great issued an order establishing a Landschaft, or landowners’ co-operative. That allowed the hard-up nobles to issue, in 1770, the first Pfandbrief: a tradable bond, secured on individual properties and the assets of the whole Landschaft. The first investors, write Fritz Engelhard of Barclays, a bank, and Friederike Sattler of Goethe University in Frankfurt in a book* marking the Pfandbrief’s 250th birthday, included merchants, royal houses and the churches.

The Pfandbrief, or covered bond, became a mainstay of German finance, in particular the mortgage market. Over time the landowners’ individual liability to bondholders ended. They were liable to their Landschaften, which in turn were liable to investors. In the 19th century Pfandbriefe came to be issued by specialised mortgage banks, which backed the bonds with housing loans. In the late 1800s building, banks and bonds boomed. Banks inevitably lent too freely and some investors lost money. A legal overhaul of...

Donald Trump admits to putting the world through a “rough patch”

Thu, 08/29/2019 - 14:45

“I THINK IT was necessary,” said President Donald Trump of the “rough patch” the world economy has been going through as a consequence of his shake-up of the global trade regime. His comments came on August 26th, towards the end of the G7 meeting of rich-world leaders in Biarritz, France, and a particularly bumpy series of trade announcements. There is still plenty of turbulence ahead.

The drama started on August 23rd, when the Chinese government announced its plans for retaliation in response to an earlier tranche of American tariffs. China’s average tariff on imports from America (weighted to match America’s global exports in 2017) will rise from 20.7% to 21.8% on September 1st, and to 25.9% on December 15th (see chart), by which time 69% of America’s exports to China will be affected.

Aircraft, integrated circuits and pharmaceuticals were spared, perhaps in recognition that tariffs on those would hurt China more. But previously announced tariffs on cars and...

Germany debates banning negative interest rates

Thu, 08/29/2019 - 14:45

“SAVE OUR savings, Frau Merkel!” begged Bild, a German tabloid, on August 26th. Articles blaming the European Central Bank (ECB) for keeping interest rates low, and seeking reassurances from banks that thrifty Germans will be spared Strafzinsen, or negative “penalty rates”, are proliferating. One in Die Welt in July feared that ECB stimulus would lead to the “ultimate expropriation” of the German saver.

German hostility to low interest rates is hardly surprising. The value of thrift has deep roots in the national psyche, going back to the Reformation. Households have €2.4trn ($2.6trn) stashed in bank deposits, almost as much as those in France and Italy combined. Last year they squirrelled away a tenth of their disposable income, twice the savings rate of Britons.

With markets pricing in a further cut at the ECB’s policy meeting on September 12th, the opposition in Germany is getting louder. Politicians spy a bandwagon. On August 21st Markus Söder, Bavaria’s premier, said his party would propose legislation to ban negative interest rates on retail deposits of less than €100,000. Olaf Scholz, the federal finance minister, has asked officials to look into the practicalities.

The ECB and its German...

India’s government is scrambling to revive the economy

Thu, 08/29/2019 - 14:45

FOR DECADES Kwality restaurant has served spiced chickpeas and fried flatbreads to traditionalists and tourists amid the colonnades of central Delhi. One prominent fan was Arun Jaitley, a former finance minister and foodie, who would drop in for an impromptu lunch when parliament was disrupted. It is fitting, therefore, that Kwality’s wood-panelled shelves hold bound copies of Excise Law Times, a journal about some of the country’s Byzantine taxes.

When Mr Jaitley died on August 24th after a long period of ill-health, the great and good from across India’s fierce political divides joined in praising his intellect and civility. But the economy he presided over for most of Narendra Modi’s first term as prime minister has shown no such sense of decorum. Figures due on August 30th are expected to show growth of less than 6% year-on-year for the second quarter in a row. India has not had such a poor run since early 2013 (see chart), during a period of policy paralysis that helped destroy the previous government.


How a Canadian firm has taken on Wall Street’s private-equity titans

Thu, 08/29/2019 - 14:45

ON THE 67TH floor of One Manhattan West, a new glass tower in the island’s drab south-west, construction managers survey the skyline. They are about to sign off on a feat of engineering. The 303-metre skyscraper is the tallest part of a $5bn office, retail and residential project covering an area the size of 100 football fields. Resting on a huge concrete slab covering active rail tracks, the weight is carried by a column sitting on the sturdiest parts. The first tenants are due to move in within weeks.

One Manhattan West is the culmination of a decades-long bet by Brookfield Asset Management. The Canadian firm bought the land in 1996 as part of its swoop on Olympia and York, a bankrupt builder. The towers are an apt metaphor for its success in alternative asset management, investing in the likes of property, infrastructure and private equity. With $388bn under management (debt included), it rivals Wall Street giants like Blackstone and Carlyle. Insiders reckon it can grow further.

Most buy-out giants were founded in recent decades by investment bankers. Brookfield, by contrast, started with São Paulo’s tramway and power lines in 1899 and spent most of its history operating infrastructure and property projects in the Americas. By 1990 it was a conglomerate of “somewhat disparate assets”, says Neil Downey of RBC Capital...

Narendra Modi’s government dips into central-bank reserves

Thu, 08/29/2019 - 14:45

MOST CENTRAL banks occupy impressive premises in expensive parts of town. Few begrudge them this perk. Nice digs seem only fitting for the guardians of the nation’s currency, giving them a reassuring air of gravitas and permanence. But is grand architecture necessary for central banks to perform their functions? Is there any economic justification for it? The honest answer is no.

What is true of central-bank architecture is also true of central-bank capital. Most such institutions have reassuring balance-sheets. Their assets, which usually comprise safe government securities, comfortably exceed their liabilities, which are chiefly the banknotes they issue and the deposits held with them by commercial banks. The assets of the Reserve Bank of India (RBI), for example, exceed its liabilities by over 9trn rupees ($125bn), of which about 2.7trn rupees is ready to hand.

This balance-sheet is a source of pride, allowing the institution to feel financially independent. Thus when Narendra Modi’s government began to argue that it was too lavishly capitalised, the RBI was displeased. And when the finance ministry concluded last year that it should give some of its excess capital to the government, which was keen to shore up public-sector commercial banks, the RBI resisted. The tussle was one reason why Urjit Patel, then its...

The World Bank’s pandemic bonds are not paying out for Ebola

Thu, 08/29/2019 - 14:45

THE EBOLA outbreak in west Africa in 2014-16 was the worst in history, with nearly 30,000 cases and a death toll of more than 11,000. It exposed a flaw in funding mechanisms to tackle such health emergencies: by the time money arrives the disease has already spread. So to speed things up the World Bank created “pandemic bonds”, a type of insurance scheme. In 2017 they were sold to private investors, who would lose their money if any of six deadly pandemics hit. In the event of Ebola, up to $150m would be released to affected countries’ governments, and agencies such as the World Health Organisation, to be used to fight the outbreak.

Last year Ebola struck the Democratic Republic of Congo. It has already killed nearly 2,000 people. But the scheme has not paid out. The 386-page bond prospectus contains a clause making payout conditional on the disease spreading to a second country, with at least 20 people dying there. Ebola has indeed spread, to neighbouring Uganda. But it has killed just three people there, with no new cases since June.

Investors, including pension funds and asset managers, had bought $320m of the bonds in a deal that was heavily oversubscribed. The notes covering Ebola give them an annual coupon of 11.5 percentage points above LIBOR, a benchmark interest rate. The World Bank, with contributions from...

China is calm as growth slows. But is it complacent?

Thu, 08/29/2019 - 14:45

HALF A DECADE ago, if you had asked economists which number—five or seven—described China’s GDP and which its currency, most would have answered this way: growth will remain strong at around 7% annually, and the currency will strengthen until it takes just five yuan and change to buy a dollar. One measure of the impact of Donald Trump’s trade war on China is the inversion of these digits. As American tariffs bite, economic forecasters think that Chinese growth next year will slow to five-point-something percent. The yuan, for its part, has slumped to more than seven per dollar.

Mr Trump has crowed about the success of his tactics. “China has taken a very hard hit,” he said on August 26th at a news conference after the G7 summit in France. “They want to make a deal very badly.” But a more accurate reading of China’s policy stance is one of surprising calm in the face of the economic slowdown and, by extension, of stiffer resolve in the trade dispute.

The toll of tariffs on China’s economy is becoming more visible. Although exports to America account for just a small share of overall GDP, the uncertainty has bruised corporate confidence. Investment spending is on track to increase this year at its weakest pace in at least two decades. Factory prices have veered into deflation, a bad sign for industrial profits. Economists...

A meeting of economists and central bankers was overshadowed by President Donald Trump

Tue, 08/27/2019 - 17:37

AS THE ANNUAL meeting of central bankers and economists at Jackson Hole, a mountain resort in Wyoming, began on August 23rd, two participants made a bet. Would President Donald Trump tweet about the opening remarks of Jerome Powell, the chairman of the Federal Reserve, within 45 minutes? In the event, it took the president 57 minutes. That night the victor enjoyed his winnings—a glass of whiskey—in the bar.

Mr Trump’s words made the conference theme, “challenges for monetary policy”, uncomfortably timely. He called Mr Powell an “enemy” and promised to ramp up trade tensions with China. Then he announced increases in tariff rates on over $500bn of Chinese imports. But even as stockmarkets reeled, the conference continued serenely. Indeed, Mr Trump even brought the assembled economists and monetary policymakers closer together.

Most obviously, they were united in grumbling about the impact of his trade policy on the global economy. Philip Lowe, the governor of the Reserve Bank of Australia, said that business uncertainty was turning political shocks into economic ones. Mark Carney, the governor of the Bank of England, said that trade tensions had raised risk premiums, thus tightening financial conditions. The president’s twitter tirade could lead to greater policy convergence, too. Mr Powell said that the Fed’s...

The Japanification of bond markets

Thu, 08/22/2019 - 14:44

IN THE 1920S E.M. Forster, an English novelist, set out the difference between a story and a plot. “The king died and then the queen died” is a story, he wrote. But a sense of causality is needed to make a plot more than just a sequence of events. “The king died and then the queen died of grief” is a plot.

Investors like stories as much as anyone. They like plots even more. A durable narrative, and one that is on everybody’s lips once again, is “Japanification”. A Forsterian summary might read: “The bubble burst, people became cautious and the economy got stuck in too low a gear to stop prices and interest rates from falling.” In its strongest form Japanification is a pure tragedy, in which rich, debt-ridden economies are destined to follow the path set by Japan. In another, softer version only countries with rapidly ageing workforces, such as Germany, are thus fated.

Germany’s bond market is now priced for endless stagnation. Its interest rates are negative on everything from overnight deposits to 30-year bonds. But it is striking how depressed bond yields are in countries with only a passing resemblance to Japan. A 30-year American Treasury yields just 2%, for instance. As currently scripted, Japanification is narrowly defined but broadly applied. It is the fear that policymakers have lost for good their ability to...

Tidjane Thiam’s overhaul of Credit Suisse is paying off

Thu, 08/22/2019 - 14:44

TIDJANE THIAM is not the first non-Swiss chief executive of Credit Suisse. His American predecessor, Brady Dougan, held the job for eight years. But Mr Dougan was an insider, having been at the firm for ages. Mr Thiam was anything but. A citizen of France and Ivory Coast, where he was a government minister in the late 1990s, he had been a consultant at McKinsey and had overseen the European arm of Aviva and the whole of Prudential, two British insurers. Before taking the top job at Credit Suisse in 2015, he had never even worked for a bank. Charming in person and intimidating and forceful by reputation, Mr Thiam walked straight into a tempest.

From the start he knew that Credit Suisse’s defences against disaster were uncomfortably thin. Its common equity tier 1 capital covered just 10.3% of risk-weighted assets (RWAs), less than at any of its peers. To bolster them Mr Thiam quickly raised SFr6bn ($6.3bn) in equity. Unleashing his inner consultant, he set about reorganising the bank’s structure, steering it towards wealth management and away from the riskier whirlpools of investment banking. Mr Thiam promised deep cost cuts from the start, when, he now says, “there is the greatest willingness to change and no ‘restructuring fatigue’”.

But within months a nightmare had unfolded. In the last quarter of 2015 Credit Suisse...

China’s interest-rate revamp highlights the slow march of reform

Thu, 08/22/2019 - 14:44

FOR A CASE study in the complexity of transitions from central planning, consider the knotty mess that is China’s interest-rate system. More than 40 years after Mao Zedong died, the country is an economic superpower, yet it still struggles to manage bank lending using interest rates, rather than through heavy-handed interventions such as credit quotas. To make this shift, the central bank has created a dizzying array of instruments. S&P Global, a rating agency, counts 20 separate monetary-policy tools in China, from newfangled liquidity-injection facilities to old-fashioned instructions to banks; America, by contrast, has just six main instruments.

Now China has modernised its arsenal with a new benchmark interest rate, unveiled on August 16th. The Loan Prime Rate (LPR), as it is known, will become the reference rate for banks pricing corporate loans. Announced monthly, it will be the average of what 18 designated commercial banks charge their best corporate clients, expressed as a spread over the banks’ own cost of borrowing from the central bank.

In theory this should make Chinese lending rates more responsive to financial conditions. Under the previous system, banks priced loans from a one-year lending rate set by the central bank. It has refrained from changing that rate since 2015, concerned, in part, that...

France is giving unilateralism a go

Thu, 08/22/2019 - 14:44

“DON’T TAX you, don’t tax me, tax that fellow behind the tree.” Historically, this rhyme has poked fun at the tax-shy American public. Today it reflects complaints against the French government, which on July 25th introduced a tax on digital services. American companies such as Amazon, Facebook and Google are protesting that they are being treated like the fellow behind the tree. President Donald Trump is itching to hit back. Unilateralism is a language he can understand.

At the heart of the dispute lies a mismatch between where companies make their profits and where those profits are booked for tax purposes. Governments wail that as data and ideas can zip across borders, taxable profits can slip between their tax-collectors’ fingers. The solution requires international co-ordination, to avoid everyone trying to tax the same stuff at once. But negotiations overseen by the OECD, a club of mostly rich countries, are taking too long for the French.

Hence their levy of 3% on the revenues generated from French users of online platforms and digital advertising. The tax is blunt, but that is part of the point. It is meant as an interim measure, to be ditched once an international agreement is reached. It could even make a deal more likely. Affected companies may prefer that to unilateral taxes, and lobby for it.


Who wins from foreign investment?

Thu, 08/22/2019 - 14:44

SHAWNEA ROSSER earned upwards of $29 an hour when she worked for General Motors in Dayton, Ohio. But in 2008 the factory closed. Years later the building was bought by Fuyao Group, a Chinese multinational company that makes glass. The new American managers promised that the “historic” project would “give people jobs, and give a future to your kids and my kids”. Sounds great. But Ms Rosser’s new job paid just $12.84.

The plight of Ms Rosser and her coworkers is captured in “American Factory”, a documentary released on August 21st by Netflix that explores the tensions that arise from the factory’s foreign ownership. There is discontent among American workers, but the source is unclear. Could it simply reflect the post-crisis reality of American manufacturing work? Or are the different Chinese employment practices to blame?

A new study offers part of an answer, by asking who benefits when foreign investors open up shop. On average, foreign companies in fact pay workers around 25% more than American ones. But that could be because they employ relatively skilled workers. Bradley Setzler and Felix Tintelnot of the University of Chicago match anonymised employee and company tax records to estimate the true wage premium.

The economists look to see what happens when American workers move between companies. They find that...

Apple and Goldman Sachs launch their credit card

Thu, 08/22/2019 - 14:44

FINDING THE One is never easy. Plenty of candidates are attractive at first, but their charms are deceptive, or simply fade. Others for whom you pine spurn you. As with love, so it is with credit cards. Bonus offers are tempting, but also fleeting. Reward points pile up, yet linger unused. Unexpected fees sting.

But now there is a sexy new stranger for Americans to eye up. On August 20th Apple launched its long-awaited credit card, in partnership with Goldman Sachs, a Wall Street firm pushing into digital consumer banking. Signing up takes about a minute. Approval (or rejection) is often instant. The card, delivered to the iPhone’s wallet app, may be used at once. (A physical titanium version will arrive in the post.) There are no fees for using the card, or even for missed payments. Instead of making you wait until the end of the month for rewards, Apple pays cash daily.

The allure goes on. What starts off as a blank white oblong in the app is slowly shaded in rainbow colours as you spend: blue for transport; orange for food; pink for entertainment. Bills are paid by sliding a circular dial, which turns a friendly green if you pay in full, an uneasy yellow for less and an alarming red for the bare minimum. Any interest you will owe, shown in the centre of the dial, changes with the payment. When you clear your bill,...