The Economist

Subscribe to The Economist feed The Economist
Finance and economics
Updated: 11 min 33 sec ago

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

Thu, 11/14/2019 - 16:01

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

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

Other schemes have...

The Trump administration is trying to reforge carmakers’ supply chains

Thu, 11/14/2019 - 16:01

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

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

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

The...

The case for a falling dollar

Thu, 11/14/2019 - 16:01

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

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

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

...

Tighter production targets have failed to lift the price of oil

Thu, 11/14/2019 - 16:01

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

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

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

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

Thu, 11/14/2019 - 16:01

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

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

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

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

Thu, 11/14/2019 - 16:01

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

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

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

The improved mood in financial markets

Thu, 11/14/2019 - 16:01

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

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

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

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

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

Thu, 11/14/2019 - 16:01

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

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

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

How Jim Simons became the most successful investor of all time

Thu, 11/14/2019 - 16:01

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

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

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

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

Revisiting the euro’s north-south rift

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.

...

Pages