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As growth slows, the spectre of local-government debt looms once more

The Economist - Thu, 06/20/2019 - 14:51

A STATUE OF a golden bull, poised to charge, stands outside the headquarters of Xiangtan Jiuhua, a government-owned company that funds much of Xiangtan’s infrastructure investment. It has seen better days: the gold paint is flaking and the torso is cracked. That makes it a fitting symbol for public finances in the sprawling prefecture of 3m people in central China, and scores of similar cities across the country, where the ambitions of local officials have collided with heavy debt loads.

Concerns about local balance-sheets in China have recurred over the past decade. Recently they have come into sharp focus again. Attempts to clean up local debts have not worked. And borrowing looks set to rise as the trade war rumbles on: China wants its provinces and cities to prop up growth by building roads and railways.

At just 38% of GDP, less than half the average in advanced economies, government debt in China might seem under control. But that misses much of what is happening. Local governments have long relied on off-balance-sheet debt to solve a perennial policy quandary. They are responsible for about 85% of public expenditures, yet command only 50% of revenues. Moreover, central authorities make it hard for them to borrow formally, hoping to limit their profligacy. So they have created entities such as Xiangtan Jiuhua,...

UBS faces a China backlash because of a quip about pigs

The Economist - Thu, 06/20/2019 - 14:51

AFRICAN SWINE FEVER has devastated China’s pigs. The country’s herd has shrunk by 20%, or roughly 100m, over the past year. The epidemic is now threatening to claim another victim: the standing in China of UBS, a Swiss bank.

Its troubles stem from a quip about the inflationary impact of the porcine pandemic, which has pushed up consumer prices. “Does this matter? It matters if you are a Chinese pig. It matters if you like eating pork in China,” Paul Donovan, global chief economist of UBS’s wealth-management arm, wrote in a note to clients. To some in China, the phrase “Chinese pig” looked insulting, even racist.

Screenshots quickly circulated among Chinese investors and analysts. Mr Donovan apologised and UBS deleted the note. Yet the anger was unabated. The Chinese Securities Association of Hong Kong called for Mr Donovan to be sacked. Haitong International Securities, a brokerage, said it would sever ties with UBS; China Railway Construction Corp decided against appointing it as a co-ordinator for a bond sale. As the pressure mounted, UBS put Mr Donovan on leave.

Some observers saw the reaction as a sign of rising anti-foreign sentiment as China’s rift with America over trade deepens. Others spied a conspiracy. UBS has been one of the most successful foreign financial firms in China and is set to play a bigger...

Who would be mad enough to take the top job at Wells Fargo?

The Economist - Thu, 06/20/2019 - 14:51

IT IS WITH relief regret that I must turn down your offer of the role of chief executive at Wells Fargo. Had you asked me four years ago I would have accepted. Back then Wells looked like a model bank, having come through the financial crisis unscathed by trading accidents or losses on toxic mortgages. Its retail arm was purring along—thanks, it seemed, to your employees’ brilliance in persuading people to open accounts. That brilliance turned out to be in fraudulently opening millions of spoof accounts, partly in order to shine in internal reports known as “Motivators”. I like a lively sales force, but Wells took it too far—and, more to the point, got caught.

Although the scandal broke back in 2016, the mess will still dominate the life of your next CEO. It is not the threat of litigation that worries me—with $20bn of annual profits the firm can easily absorb the worst that America’s lawyers can throw at it. Far scarier are regulation and politics.

Federal supervisors have imposed more than a dozen restrictions on Wells until it shows it has better safeguards in place. These include capping assets at their 2017 level of $1.95trn. This has hobbled the firm. Since then it has shrunk by 3% even as JPMorgan Chase’s assets have grown by 8%. Although the cap may be lifted in 2020, relations with regulators are...

Can Germany’s biggest lender survive on its own?

The Economist - Thu, 06/20/2019 - 14:51

EARLIER THIS month, following the collapse of merger talks with Commerzbank in April, Deutsche Bank’s share price hit the lowest point of its 149-year history. Fitch, a credit-rating agency, cut the bank’s rating to two notches above junk. In May Christian Sewing, its chief executive, promised “tough cutbacks” in the ailing investment-banking business, with plans to be laid out alongside half-year results on July 24th. But on June 16th a leak in the Financial Times revealed the outlines.

The cuts (which Deutsche has not confirmed) go well beyond its investment-banking arm. Its rates and equities trading business outside Europe will be trimmed, and a “bad bank” created to hold non-core assets that generate little or no revenue. At up to €50bn ($56bn), that is a sizeable chunk of Deutsche’s risk-weighted assets. Cuts to the underperforming trading operations had been expected, but the idea of a non-core unit is new. Like several other big banks, Deutsche had shoved €128bn of debts into a bad bank in the wake of the financial crisis. After years of restructuring, it is hard to see how on earth it still has dud assets on its books. But apparently so.

Can the moribund Teutonic giant be shaken back into life? After the leak its share price rose 2%, only swiftly to sink again. Investors fear the changes...

In Argentina, the IMF has been neither toxic nor triumphant

The Economist - Thu, 06/20/2019 - 14:51

“WHAT GOOD is it to throw a man ten feet of rope if he is drowning in 20 feet of water?” asked Kenneth Rogoff, former chief economist of the IMF, in this newspaper 15 years ago. His question still bothers the institution he used to advise. Last June the fund uncoiled its biggest-ever loan: $50bn for Argentina. Four months later it added $6bn more. It hoped its generosity would rescue Argentina and salvage its reputation in a country that regards it as complicit in the economic disasters of 2001-02. But a year later, Argentina’s economy is still far from safety. Will more rope be needed?

The first thing a drowning man should do is jettison excess weight. Argentina’s government, led by Mauricio Macri, has slashed its fiscal deficit, aiming to balance the budget this year, excluding interest payments and some capital and social spending approved by the IMF. That austerity has helped squeeze imports, turning the trade deficit into a surplus.

But such fiscal rigour will be hard to sustain. And imports are not the only claim on Argentina’s dollars. It must make substantial payments on foreign debt in 2020, when the inflow of dollars from the IMF’s three-year loan will slow dramatically. Many analysts think it will eventually need a new, longer IMF loan to help it pay back the existing one.

Investors also fear a...

Buy-out firms are the new banks in emerging markets

The Economist - Thu, 06/20/2019 - 14:51

ENERGY PRODUCERS have long had India over a barrel. It is the world’s third-largest oil importer, yet its pipeline density is a quarter of the global average. It aims to add 15,000km by 2022, awarding projects through strict online tenders. The few groups able to qualify can hope for sweet profits—if they can first find financing.

This is at last becoming easier. In emerging markets, a new breed of lenders has begun acting as credit supermarkets, offering anything from working capital to multi-year debt. They look and quack like banks, but are in fact buy-out firms investing mostly rich-world money. As demand for financing surges in fast-growing countries, they will proliferate, says Kanchan Jain of Baring Private Equity Asia. Her firm is nearing a four-year debt investment in a business that lays pipes in India.

The surge reflects investors’ continuing hunt for yield. Ultra-low interest rates since the financial crisis have depressed returns in the West, nudging them towards economies with more alluring prospects. After stocks, bonds and private equity, private credit is their latest target. Last year over 50 emerging-market private-debt funds closed, having reached their funding target, up from 14 a decade ago. They raised $9.4bn in total, a sevenfold rise since 2008. Michael Casey of Portico, an advisory firm, says...

Low interest rates and sluggish growth may lead to currency wars

The Economist - Thu, 06/20/2019 - 14:51

IN 2010, AS the euro zone’s sovereign-debt crisis escalated, the euro fell sharply, from $1.45 to $1.19. Soon the talk in America was of a second round of quantitative easing by the Federal Reserve. Was this a coincidence? Many in euro land thought not. QE2, as it came to be known, seemed to them to be mostly a means to a weaker dollar. The grumbles went beyond Europe. That September Guido Mantega, Brazil’s finance minister, said his country was under fire in an international currency war.

Now the bellyaching comes from America. On June 18th Mario Draghi, the president of the European Central Bank (ECB), said at a conference in Sintra, Portugal, that the bank stood ready to relax its monetary policy further if the euro-zone economy did not improve. Bond yields fell. So did the euro. President Donald Trump took to Twitter to denounce Mr Draghi for “unfair” currency manipulation. Earlier this month Steven Mnuchin, Mr Trump’s Treasury secretary, had fired a warning shot in the direction of Beijing on currency policy. If China stopped trying to support the yuan, he seemed to suggest, that could be understood as an effort to weaken it.

The guns have been holstered again. The prospect of a pow-wow between Mr Trump and Xi Jinping, China’s president, at a G20 summit in Osaka later this month has raised hopes that, at the very...

The rising cost of education and health care is less troubling than believed

The Economist - Tue, 06/18/2019 - 17:10

AMONG THE compensations of ageing is the right to bore youngsters with stories of the prices of yesteryear. Once upon a time a ticket to the cinema cost just five quid, and a hogshead of mead but a farthing. Of course, savvier youths know how to debunk such tales. Adjust for inflation and many things are cheaper than ever. Since 1950 the real cost of new vehicles has fallen by half, that of new clothing by 75% and that of household appliances by 90%, even as quality has got better. Tumbling prices reflect decades of improvements in technology and productivity. But the effect is not economy-wide. Cars are cheaper, but car maintenance is more expensive, and costs in education and health care have risen roughly fivefold since 1950. Though no mystery, this rise is often misunderstood, with serious economic consequences.

There are as many explanations for the ballooning cost of such services as there are politicians. But as a newly published analysis argues, many common scapegoats simply cannot explain the steady, long-run rise in such prices relative to those elsewhere in the economy. In “Why are the prices so damn high?” Eric Helland of Claremont McKenna College and Alex Tabarrok of George Mason University write that quality has improved far too little to account for it. Administrative bloat is not the answer either. In America the...

Why an anti-poverty programme in Bangladesh failed

The Economist - Thu, 06/13/2019 - 14:26

A YEAR AND a half ago The Economist wrote about a promising approach to cutting poverty in Bangladesh (“On their bikes”, January 27th 2018). RDRS, a charity, was offering small loans to more than 100,000 poor farmers on the condition that they migrated temporarily to a city for work. Everything seemed to be set fair. Smaller randomised controlled trials had shown that many men could be persuaded to move while the rice crop is growing, when there is not much work to be done at home. Although the migrants found only low-paid jobs, as rickshaw drivers, building labourers and the like, their fortunes had greatly improved. It looked like a true poverty cure.

Sadly, things soon began to go wrong. Evidence Action, the charity overseeing the scheme, heard rumours that somebody involved with the project may have sought to bribe a government official, though it could not substantiate them. More damningly, as the data came in, it became clear that in 2017 few men had been persuaded to migrate. On June 6th Evidence Action announced it was shutting down the scheme. What looked like a miracle cure for poverty now seems like a warning about the pitfalls of development...

A former official casts doubt on India’s GDP figures

The Economist - Thu, 06/13/2019 - 14:26

ALMOST TWO years ago Arvind Subramanian, then India’s chief economic adviser, published a little-noticed passage in the finance ministry’s annual economic survey. The previous two years posed a “puzzle”, he wrote. India had reported miracle growth in GDP (averaging 7.5%) despite miserable growth in investment, exports and credit. He looked for comparable examples elsewhere since 1991. He found none. No country had grown faster than 7% in such circumstances. None, in fact, had grown faster than 5%. India’s rapid expansion, he warned, might be hard to sustain.

Or, indeed, hard to believe. Mr Subramanian’s official position meant he could not say that loudly then. But he is saying it now. In a paper published by Harvard University, where he is a visiting fellow, he argues that India’s growth figures have been greatly overstated. From the 2011-12 fiscal year to 2016-17, its economy officially expanded by about 7% a year, eventually outpacing China’s to become the fastest-growing big economy. That boast has helped entice over $350bn of foreign investment in the past seven years. But India’s true growth, Mr Subramanian thinks, is more like 4.5%. Rather than outperforming China, India has underperformed Indonesia.

His paper starts by reporting a variety of indicators that have slowed sharply since 2011-12, even as growth has...

Robert Merton and the effect of time on portfolio choice

The Economist - Thu, 06/13/2019 - 14:26

FINANCE THEORISTS are, as everybody knows, unworldly people who can scarcely tie their shoelaces, still less change a car tyre. Robert Merton confounds this stereotype. As he talks amiably at the London office of Dimensional Fund Advisors (he is the firm’s “resident scientist”), you sense that here is a man who could fix a flat in no time. He would probably deliver a cheerful lecture on the importance of the correct tyre pressure while he was tightening the wheel nuts.

Mr Merton has always had a bent for engineering, whether financial or mechanical. He bought his first stock aged ten and completed a risk-arbitrage trade (on a takeover by Singer, a maker of sewing-machines) aged 11. He rebuilt his first car aged 15. In 1997 he won the Nobel prize for economics aged 53—a career high. A year later, a career low: LTCM, the hedge fund he co-founded, imploded. These markers of the passing years matter. For Mr Merton’s specialism is the mathematics of time applied to finance.

His first paper on the subject was published almost exactly 50 years ago. Its title—“Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case”—is forbidding. The ten pages of equations that follow are daunting. But for Mr Merton, the equations are tools, no different from a car jack. They allowed him and subsequent researchers to clarify...

The ECB presidency is distinct but not immune from backroom deals

The Economist - Thu, 06/13/2019 - 14:26

“THE LONGEST lunch in history” is how Jonathan Powell, an adviser to Tony Blair, a former British prime minister, has described the appointment of the first head of the European Central Bank (ECB) in 1998. The French, keen to have their man in the job, had convinced the Germans that Wim Duisenberg, a Dutchman, should serve only half of his eight-year term before making way for a Frenchman. Mr Duisenberg resisted, giving in only after midnight.

The choice in 2011 of the third and current president, Mario Draghi, an Italian, involved less drama. Even so, France and Italy fell out after Lorenzo Bini Smaghi, another Italian on the bank’s six-strong executive board, initially refused to give way to a French national. “What can I do? Shall I kill him?” Silvio Berlusconi, then Italy’s prime minister, asked Nicolas Sarkozy when his French counterpart complained.

Mr Draghi departs in October. What tales will be told of his successor’s selection? The scope for theatrics is greater than ever. The choice is always political: national leaders make nominations and eventually agree on a name. But Mr Draghi’s term ends in the wake of European elections, as they are also deciding other top jobs. At a summit on June 20th-21st the European Council of leaders aspires to pull off a package deal covering the key roles. Succeed or no, the...

Martin Feldstein was a pillar of American economics

The Economist - Thu, 06/13/2019 - 14:26

FOR A HALF-CENTURY Martin Feldstein was everywhere you looked in American economics. He was an astoundingly prolific columnist, sometimes churning out several a week, for several newspapers, on the big economic stories of the day. He was a fixture at conferences and seminars and the teacher, for two decades, of Harvard University’s introductory economics course. He served presidents of both parties. In short Mr Feldstein, who died on June 11th aged 79, was an American economic institution.

Born in New York City, he spent most of his life in Cambridge, Massachusetts, at Harvard, where he moved in 1967 after a doctorate at Oxford. His early career was remarkably productive. In 1974 he published an influential paper examining how Social Security, America’s public pensions system, affects saving patterns. Astonishingly, he concluded that the programme reduced personal saving by between 30% and 50%; throughout his life he was a staunch advocate for its reform.

In work with Charles Horioka he identified one of the great enigmas in international economics, now known as the Feldstein-Horioka puzzle. Economists reckon that capital free to move should go where returns are highest. There should therefore be little correlation between a country’s savings and domestic-investment rates, since places with too little investment should...

Digital technology will strengthen America’s biggest retail banks

The Economist - Thu, 06/13/2019 - 14:26

BY ALMOST ANY measure, America’s biggest banks are behemoths. JPMorgan Chase’s balance-sheet weighs in at $2.7trn, Bank of America’s (BofA) at $2.4trn. Citigroup tips the scales at almost $2trn and Wells Fargo at $1.9trn. Their combined market value is nearly $1trn. Last year they raked in over $100bn after tax.

Yet by one gauge, the titans are curiously tiny. Together that quartet holds only about a third of Americans’ deposits (see chart). The biggest names in other rich countries, from Canada to Sweden, have far larger shares. Perhaps only Germany’s market, with its hundreds of municipal and co-operative banks, is similarly fragmented.

Despite years of mergers, including several mid-crisis in 2008-09, America still has over 5,300 banks. Almost 5,000 are “community” banks, mostly with assets below $1bn, which collectively hold 15% of deposits. Even the giants are still filling gaps, the fractured geography of their retail networks reflecting the genealogy of past mergers. BofA opened branches in Pittsburgh only last year and in Salt Lake City in January. The first Chase branches in Boston and Washington opened in late 2018.

...

The market believes the Fed will cut rates by September. Should it?

The Economist - Wed, 06/12/2019 - 20:10

THE FEDERAL RESERVE is changing direction. In December it predicted that it would raise the federal funds rate twice in 2019, to 2.75-3.0%. In March it thought it would hold rates steady instead. Investors now think there is a one-in-five chance that it will cut rates at its meeting on June 19th, and a 95% chance that it will do so by September (see chart). Jerome Powell, the Fed’s chairman, has said it is “ready to act”.

The reason for the change is a darkening world economy, caused primarily by the failure of America and China to strike a deal to bring their trade war to an end. Yet for all the ructions, the visible impact on America’s hard economic data has so far been relatively small. True, American firms hired only 75,000 workers in May, on first estimate, well below the recent monthly average. But jobs data are volatile, and the unemployment rate is a very low 3.6%.

Where the pain of the trade war has shown up is mainly in financial markets. The ten-year Treasury yield, for instance, was 2.5% in early May but has since fallen to 2.1% as investors have rushed to safety and anticipated rate cuts. Large moves like these raise an uncomfortable question for the Fed. Should it yield to the market, thereby risking the appearance that monetary policy is set by traders? Or should it consider only backward-looking economic...

How compatible are democracy and capitalism?

The Economist - Tue, 06/11/2019 - 16:36

OF LATE THE world’s older democracies have begun to look more vulnerable than venerable. America seems destined for a constitutional showdown between the executive and the legislature. Brexit has mired Britain in a constitutional morass of its own. Such troubles could be mistaken for a comeuppance. In recent years political economists have argued that rising inequality in the Anglo-American world must eventually threaten the foundations of democracy; a book on the theme by Thomas Piketty, a French economist, has sold well over a million copies. That argument channels a time-worn view, held by thinkers from Karl Marx to Friedrich Hayek, that democracy and capitalism may prove incompatible.

As powerfully as such arguments are made, the past century or so tells a different story. The club of rich democracies is not easy to join, but those who get in tend to stay there. Since the dawn of industrialisation, no advanced capitalist democracy has fallen out of the ranks of high-income countries or regressed permanently into authoritarianism. This is not a coincidence, say Torben Iversen of Harvard University and David Soskice of the London School of Economics, in their recent book, “Democracy and Prosperity”. Rather, they write, in advanced economies democracy and capitalism tend to reinforce each other. It is a reassuring message, but one...

How to stop governments borrowing behind their people’s backs

The Economist - Mon, 06/10/2019 - 11:04

IN 2016 THE government of Mozambique confessed to secret debts of $1.4bn, or 11% of GDP, mostly as loan guarantees for state-backed companies. Growth faltered, the currency slumped and foreign donors pulled back. The results have been “devastating”, says Denise Namburete, a civil-society activist, describing health centres that have gone two years without medicines. American prosecutors are pursuing eight people involved in the scandal, including three foreign bankers and a former finance minister, on charges of money-laundering and fraud.

The Mozambique case may be unusual—or not. Even the IMF is scratching its head about how much governments truly owe. In some places the mystery is loans from China and other emerging lenders. In others it is advance payments from oil traders, liabilities from public-private partnerships or hidden loans from commercial banks. The Institute of International Finance (IIF), a group of banks and financial institutions, has responded to mounting concern by drafting principles on debt transparency. Finance ministers of G20 countries endorsed them at a summit in Fukuoka, in Japan, on June 8th-9th.

The IIF principles are voluntary and would apply only to lending from the private sector, not from states. Lenders would disclose any loans they make to low-income governments or state firms within...

LIBOR is due to die in 2021. Hurry up and drop it, say regulators

The Economist - Thu, 06/06/2019 - 14:34

JUST DROP off the key. Yes, it means breaking a complicated yet rewarding long-term relationship: $240trn-worth of derivatives, loans and bonds are priced off LIBOR, the London Interbank Offered Rate; $200trn-odd are in dollars alone. But this key interest rate is due to die. Almost two years ago Andrew Bailey, the head of Britain’s Financial Conduct Authority (FCA), LIBOR’s regulator, in effect said it would expire at the end of 2021. In recent days American and British supervisors have again urged banks: hop on the bus.

A few years ago LIBOR was undermined by a rate-rigging scandal which highlighted ills that might anyway have proved fatal. Notionally, it is the rate at which banks can borrow from each other, for up to a year, in dollars, sterling, Swiss francs, yen and euros. It is calculated from daily submissions of panels of 11 to 16 banks. But banks now scarcely tap interbank markets. On June 5th Sir Dave Ramsden, a deputy governor of the Bank of England, said that in the first quarter of 2019 on average only nine deposits totalling just £81m ($105m) a day underpinned six-month sterling LIBOR.

Regulators want markets to move to new benchmarks based on overnight rates and a far richer seam of transactions. America’s Alternative Reference Rates Committee (ARRC), a group of market participants convened by the...

The Federal Reserve is reviewing its monetary-policy framework

The Economist - Thu, 06/06/2019 - 14:34

“MOST OF AMERICA thinks the Federal Reserve is a national forest.” That reminder that the general public has little idea what a central banker does was offered by an incumbent governor of the Federal Reserve to Alan Blinder when he joined in 1994. He passed it on 25 years later, on June 4th, to a star-studded group of economists and policymakers gathered at the Federal Reserve Bank of Chicago to discuss the Fed’s first public review of its framework.

The review is a year-long exploration of how the Fed should adapt to trying economic times. It typically slashes interest rates by around five percentage points in a recession. But chronically low rates mean that it now has less than half of that room for manoeuvre. The Fed is seeking to answer three questions. Should it update its forward-looking inflation target to consider past inflation too? Should its toolkit be expanded? And could it communicate and implement its policies better?

What connects all three is the difficulty of managing expectations. At the effective lower bound, where interest rates are at or very near to zero, the Fed cannot simply slash short-term rates. It must either try other sorts of interventions in financial markets—or make promises and hope they are believed. In theoretical models, such expectation management can be extraordinarily powerful. If...

In its second term, will India’s ruling coalition be bolder about reform?

The Economist - Thu, 06/06/2019 - 14:34

INDIA’S NEW finance minister, Nirmala Sitharaman (pictured below), is an unusual figure in the country’s politics. She is the first woman to head the finance ministry since Indira Gandhi seized the post (while also serving as prime minister) 50 years ago, after nationalising many of India’s banks. She is an economist. But unlike most in her Bharatiya Janata Party (BJP) she hails from the country’s south, having grown up in Tamil Nadu, one of the few big states to resist the BJP’s advances in the recent election. She claims a humbler background than her predecessor, Arun Jaitley. Her father worked for India’s railways and she spent a month selling home furnishings at Habitat, a shop in London.

Ms Sitharaman thus embodies the BJP’s broadening appeal to aspirational Indians outside its traditional heartlands. But will she help it fulfil those aspirations? On the day she was appointed, India’s statistical authority reported that growth in the first quarter of the year had slipped to 5.8%, its slowest since Narendra Modi was elected prime minister in 2014 (see chart). The government also belatedly released a report it had withheld showing that unemployment had risen to 6.1% in the year ending June 2018. In India, the jobless are often not the poorest, who cannot afford not to work, but the newly educated, qualified for better jobs that...

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