Aurelia Butler

Hello everyone, this is Akito from Singapore.In the mid-1980s, when I was a child, my family moved from Japan to Europe for my father’s work. This was in the midst of the cold war, and I remember vividly that the Japan Airlines flight we took to Europe went via Anchorage, Alaska. However, when we returned to Japan a few years later, our plane flew over the Soviet Union as tensions were easing.About 20 years later, I was in Silicon Valley as a Nikkei reporter and globalisation was advancing at a breathtaking pace. Entrepreneurs flocked to the area from around the world, including China and Russia, while US venture capitalists started investing in Chinese tech companies. Around the same time, American tech companies began using China as a major production base. Looking back, those were the “good old days”, when the distance between markets was shrinking rapidly.“In the long history of international relations, the ‘good old days’ you experienced in the Valley are rare,” a former diplomat here in Singapore told me a few months back. He pointed to past examples of conflict between powerful nations, such as second world war and the cold war.Unfortunately, he also had a current example: the growing tensions between the US and China.Tangled up in techThose tensions are raising tough questions for US tech companies. Many of them still depend on China for much of their sales, write Nikkei staff writers Akito Tanaka and Grace Li.An analysis of financial data by Nikkei Asia shows that of the top 100 global companies in China by sales in the most recent fiscal year, 17 were US tech-related companies.Apple topped the list, while Qualcomm, a major US chip company, depends on China for more than 60 per cent of its sales. Electric-car maker Tesla relies on China for over 20 per cent of its sales.This dependence on China has changed little despite efforts at decoupling the two countries’ tech supply chains. Greater China remains Apple’s second-largest source of revenue, following the company’s home market. For Tesla, China’s importance has grown by leaps and bounds. In 2022 it made 22 per cent of its total sales in the country, up from 8 per cent in 2018.Like the former diplomat who sees tension as more common than harmony in the global order, many analysts expect the US-China conflict to continue. Leaders of US tech companies whose strategy has been to court the Chinese market will have to “accept that a new status quo is forming”, according to one such expert.Join us on July 20 for a webinar featuring Chris Miller, author of the award-winning book ‘Chip War’, and Nikkei Asia’s tech journalists. Register here for an inside look at the global battle for semiconductor dominance.New rules for new techChina plans to tighten its rules governing artificial intelligence as Beijing seeks to strike a balance between encouraging developers to advance the technology and a desire to control content, writes the Financial Times’ Qianer Liu.The Cyberspace Administration of China, the powerful internet watchdog, aims to introduce measures that will require companies to obtain approval before they release generative AI products, said people close to the regulators.The update is part of regulations to be finalised as early as this month, according to people with knowledge of the move.It contrasts with draft regulations issued in April that gave tech companies 10 working days to register their products once they had launched them. That document demands companies train their generative AI models with “veracity, accuracy, objectivity and diversity” and makes them almost fully responsible for the content their AI creates.The latest move in China’s AI regulatory regime signals how the government is struggling to reconcile a desire to develop world-beating technologies with its longstanding censorship regime.Beijing is keen to formalise its regulatory approach to generative AI before the technology — which can quickly create humanlike text, images and other content in response to simple prompts — becomes widespread.An eye for AIChina’s artificial intelligence boom is proving a strong pull for US companies, even as the two countries engage in tit-for-tat trade restrictions on tech-related goods and materials.The recent World Artificial Intelligence Conference in Shanghai drew executives from Tesla, Microsoft and other big American companies looking to tap the country’s emerging AI market, write Nikkei staff writers Tomoko Wakasugi and Shunsuke Tabeta.“I think there’s an immense number of very smart, very talented people in China,” Tesla CEO Elon Musk said in a video message at the event. Google had a booth at the venue — despite its services being blocked in China — while executives from Microsoft appeared on stage.US tech has its sights set on China despite the souring relationship between Washington and Beijing because of the potential scale of its AI market, which market researcher IDC forecasts to more than double between 2022 and 2026 to $26.4bn.Channelling AsiaNetflix co-founder Reed Hastings once said in an interview with Nikkei that one of his favourite series is Midnight Diner, a show based on a Japanese manga.Now, the company is investing heavily to create new content in Asian markets like South Korea, Japan and India, recruiting new partners and searching for emerging talent to capture audiences in the increasingly important region, write Nikkei staff writers Rei Nakafuji and Kotaro Hosokawa.Netflix co-CEO Ted Sarandos visited Seoul last month and met with production company executives and creators as part of the trip. The company signed a five-year contract with Yuji Sakamoto, who won best screenplay for the film Kaibutsu (Monster) at this year’s Cannes Film Festival.In India, Netflix signed a multiyear contract with director Hansal Mehta following the success of his crime drama ScoopNetflix’s Asia push comes as the platform faces cut-throat competition at home, slowing growth. Revenue increased about 4 per cent on the year to $8.16bn in January-March, falling short of market expectations. Net profit dropped 18 per cent to $1.31bn.Suggested readsNvidia in talks to be an anchor investor in Arm IPO (FT)Foxconn withdraws from $19.5bn chip JV with India’s Vedanta (Nikkei Asia)Apple’s headset headache: the tiny and costly displays inside the Vision Pro (FT)Huawei unveils latest AI model as ChatGPT boom rolls on (Nikkei Asia)Indian ride-hailing upstart BluSmart takes on Uber with electric cars (FT)Japan to give $530mn for new Sumco silicon wafer plants at home (Nikkei Asia)Shenzhen, China’s ‘city of young migrants,’ at point of inflection (Nikkei Asia)Ant Group launches $6bn buyback after regulatory crackdown ends (FT)Byju’s taught a lesson by investors unhappy with online learning group (FT)Sony dives into ‘extended reality’ with $2bn R&D war chest (Nikkei Asia)#techAsia is co-ordinated by Nikkei Asia’s Katherine Creel in Tokyo, with assistance from the FT tech desk in London. Sign up here at Nikkei Asia to receive #techAsia each week. The editorial team can be reached at [email protected]. More

Good morning. Former retiree Bob Iger has been given a couple more years as “interim” CEO of Disney, and the ceiling on his bonus pay has been quintupled. This reminds us of an old Peter Arno cartoon depicting a bunch of ancient gentlemen seated around a long table, wearing wrinkled grins. The caption: “Then it’s moved and seconded that the compulsory retirement age be advanced to ninety-five!” Feel young at heart? Email us: [email protected] and [email protected]. That disinflation sensationAlthough we passed the inflation inflection two months ago, the speed of inflation’s descent has remained in doubt. Yesterday’s CPI numbers offered reassurance on that front. Core inflation, which had seemed hot and sticky for six months running, rose less than an annualised 2 per cent in June. Goldman Sachs called it a “turning point”; for Standard Chartered, it was a “game changer”.The details looked encouraging, too. Used car prices fell, finally relenting from a shortlived demand pop. Core goods prices declined slightly. Core services inflation rose a modest 0.25 per cent, in line with the pre-Covid average. The cooling in core services prices was helped by slower rent inflation. Newly-signed leases are trickling into the CPI data, which also includes old, peak-inflation leases. This transition takes time, so the economist Jason Furman uses private market rental data to simulate where core inflation will settle once CPI finishes catching up. On a six-month annualised basis, core CPI would be at 2.5 per cent if CPI shelter fully reflected private market rents.A few notes of caution are needed. Next month’s report may not be so benign on the services side. Hotels and airfares, two volatile services categories, posted huge price drops, at 2 per cent and 8 per cent month on month, respectively. These will probably reverse. And other services categories such as vet visits, recreational services, car insurance and repairs are all still running hot (for a deeper discussion of car insurance inflation, listen to the Unhedged podcast).But good news is good news. Most encouraging of all, inflation appears to be unsticking. The indices below measure, in different ways, how broadly entrenched inflation is. All three are pointing in the right direction, and one is even sporting a 2-handle:The market was pleased. Falling yields carried stocks gently higher. Calmer inflation means rates don’t need to go as high, or for as long, as the market had expected. After the CPI report, the futures market lowered its probability estimate of a second additional rate increase this year (the one in July still looks all but guaranteed). The two-year yield fell 13 basis points, confirming the signal from the futures market.But these were incremental moves, reflecting the incremental information contained in yesterday’s report. The data did not guarantee a soft landing, but suggested what the path may be. That is: decelerating job growth plus lower core inflation buys room for the Federal Reserve to go easier. The chance of that happening is on the rise, but things need to keep going right, so Mr Market is reserving judgment. As BNP Paribas analysts wrote yesterday, “the market may require either confirmation of a trend softening in inflation or signs that the labour market is cracking to shift regimes”.Two questions linger. One is whether progress on inflation will get harder. Growth is still strong, the labour market is still tight, and private market rent indices have re-accelerated, suggesting shelter inflation won’t fall for ever. A second is what the Fed will do if the chances of a soft landing keep rising. Cut early to stop the lagged effects of policy from derailing the economy? Keep rates high to make sure the job is done? We’re past halftime for this rates cycle, but there’s plenty of game left to play. (Ethan Wu)A reply on bank capitalThere were quite a few lively responses to yesterday’s piece on the bank capital proposals from the Fed’s Michael Barr. Most of them were approving, but there were some interesting points of dissent. Several readers took the line that our friend Matt Klein (everyone subscribe to The Overshoot!) laid out in an email:A partial defence of Barr: I think of capital as a way to reduce the risk of flight from uninsured depositors and other creditors, because runs are usually predicated on concerns about the distribution of losses. Silicon Valley Bank and First Republic would not have had those kinds of outflows if depositors knew that someone else would be on the hook for underwater bonds and loans . . . Given the outflows they had, more capital would not have helped, but maybe a different balance sheet structure would have prevented the runs in the first place. In other words, more capital would not have helped once the run began, but a thin capital layer made the run more likely. This is a plausible view, though I think it’s probably wrong (the Barr point I called “almost total nonsense” was the idea that different capital treatment of “available for sale” securities would have helped prevent the SVB and First Republic failures). If you read back through Unhedged’s coverage of SVB and First Republic, you might find some support for this view, in fact. We noted several times that one way to screen for weak banks is to see what capital levels would be if securities portfolios were marked to market. Here is a table from our newsletter of March 14: 

The third column, the leverage ratio, is a measure of capital strength (tier one equity capital/assets). The far-right column is the leverage ratio if capital were reduced to reflect unrealised securities losses. Back then, terms like “mark to market insolvent” were thrown around a lot, and in the case of SVB, that term was accurate. And it seems pretty safe to assume this kind of talk helped precipitate the run that overwhelmed the bank.So you might say, with Barr, that a few more percentage points of capital might have decreased the chance of a run. Of course, First Republic was not mark-to-market insolvent — not even nearly — and it got crushed by a depositor run, too; but things are different for the second bank to fall than for the first. So there seems to be an argument here in favour of Barr’s view, which urges that higher capital levels increase “resilience”, by which he means the ability to survive losses whatever their source. I don’t buy this. The ultimate source of the SVB failure was catastrophically bad rate risk management combined with a flighty, concentrated, uninsured investor base. If we think that the SVB mess proves we need better regulation and supervision, the target ought to be the ultimate cause of the problem. Maybe we ought to change the way we risk weight long-term government-backed securities. Maybe we ought to have asset-liability matching rules, or require more capital just for banks with lots of uninsured deposits. Or whatever.But to argue that all banks need more capital at all times because a tiny handful of them forgot fundamental principles of risk management seems looney to me. Because higher capital requirements have a cost. Higher capital requirements are nothing but a requirement that banks lend less, and especially when the economy is soft, we don’t want less bank lending, we want more of it. I hate to sound like a bank lobbyist, but there it is.There may be good arguments that show that all banks need more capital. The SVB mess is not one of them.One good readThe Economist rubbishes the concept of “greedflation”, which needed it (good week for them; they also had a nice piece on the Minivan Taliban). More

AT&T has a lot of debt. The US telecommunications company’s total borrowings stretch well north of $130bn, a bigger debt pile than many countries.AT&T also has a lot of what could be termed “hidden debt”. Hidden, that is, until a recent accounting change cast a light on billions of dollars of liabilities buried in its books for the first time.As astute readers may have already guessed, FT Alphaville is talking about supply-chain finance, a once-niche way of juicing corporate balance sheets that became notorious when specialist firm Greensill Capital imploded in 2021.*For the uninitiated, supply-chain finance is sometimes called “reverse factoring”, because it is a newer spin on the centuries-old technique of “factoring” invoices to raise cash. In simple terms, a (typically large) company has an agreement with a financial institution to pay the bills it owes to its suppliers earlier than planned. While the smaller suppliers get paid more quickly, the trade-off is that they receive slightly less than they’re owed. The financial institution later collects the full amount of the invoice from the large company, pocketing the difference.Here are the basics in chart form, for those who like arrows going back and forth:The technique has all sorts of balance-sheet flattering benefits, such as helping a company push out the time it takes to pay its bills (increasing its “days payable outstanding”). But the most notorious one is this: while a company that uses supply-chain finance owes money to a financial institution, accountants do not class these facilities as debt.The key problem for investors trying to get to grips with companies’ use of supply-chain finance has been the lack of disclosure. Supply-chain finance obligations are typically booked through the “accounts payable” line of a company’s balance sheet, where they are co-mingled with all the other bills owed to suppliers. If you’re lucky, a footnote might explain how much of the money is actually owed to financial institutions, rather than suppliers. However, historically there was no requirement to disclose the use of supply-chain finance.In the US, the Financial Accounting Standards Board has recently tried to close this loophole, last year introducing new accounting rules mandating companies to disclose their use of what FASB terms “supplier finance”.As a result, scores of US companies disclosed their supply-chain finance programmes for the first time in their first-quarter results this year. Our friends at Bloomberg totted up $64bn of hitherto “hidden leverage” revealed across corporate America through these disclosures, producing this handy chart of the biggest users of supply-chain finance:

© Bloomberg

But FTAV noticed that one household name is conspicuously absent from this top five, even though it has what can be broadly termed “payables finance” programmes stretching to nearly $13bn. And in trying to understand why the company in question does not class all of these facilities as supply-chain finance, we hit upon some of the critical limitations of the new FASB-mandated disclosures.The Texas three-stepBefore we delve into the nitty-gritty of AT&T’s supplier finance disclosure, it makes sense to look at rival telecommunications company Verizon’s as a benchmark.After all, not only are both companies fierce competitors in the US wireless communications market, but they both carry investment-grade credit ratings (albeit the three major agencies rank Verizon’s debt one notch higher).Here is Verizon’s latest disclosure in full, taken from its quarterly report for the period ended March 31, 2023:We maintain a voluntary supplier finance program (SFP) with a financial institution which provides certain suppliers the option, at their sole discretion, to participate in the program and sell their receivables due from Verizon to the financial institution on a non-recourse basis. The eligible suppliers negotiate the terms directly with the financial institution and we have no involvement in establishing those terms nor are we a party to these agreements.Our payments associated with the invoices from the suppliers participating in the SFP are made to the financial institution according to the original invoice terms generally at 90 days from the invoice date and for the original invoice amount. No additional payments are exchanged between Verizon and the financial institution related to the SFP. Verizon does not pledge any assets nor provide any guarantees to the financial institution in connection with the SFP. The SFP can be terminated by Verizon or the financial institution with a 60-day notice period.Confirmed obligations outstanding related to suppliers participating in the SFP are recorded within Accounts payable and accrued liabilities in our condensed consolidated balance sheets and the associated payments are reflected in the operating activities section of our condensed consolidated statements of cash flows. As of March 31, 2023 and December 31, 2022, $705 million and $1.0 billion, respectively, remained as confirmed obligations outstanding related to suppliers participating in the SFP.As these new disclosures go, it seems fairly benign. The New York-based telco does not appear to be stretching out its payables for an egregiously long time (in contrast, some other companies have disclosed that they do not repay the financial institutions involved for as long as a year) and the amounts are relatively small. Verizon’s $705mn outstanding at the end of the first quarter of 2023 represents a small fraction of its $19bn accounts payable and an even smaller fraction of its $153bn total debt.Turning to its Dallas-based competitor, however, and the numbers involved are not only much bigger, but the disclosure is more convoluted:Supplier Financing ProgramWe actively manage the timing of our supplier payments for operating items to optimize the use of our cash and seek to make payments on 90-day or greater terms, while providing suppliers with access to bank facilities that permit earlier payment at their cost. Our supplier financing program does not result in changes to our normal, contracted payment cycles or cash from operations.At the supplier’s election, they can receive payment of AT&T obligations prior to the scheduled due dates, at a discounted price to the third-party financial institution. The discounted price paid by participating suppliers is based on a variable rate that is indexed to the overnight borrowing rate. We agree to pay the financial institution the stated amount generally within 90 days of receipt of the invoice. We do not have pledged assets or other guarantees under our supplier financing program.Based on data from our financial institution partners, suppliers had elected to sell $2,557 of our outstanding payment obligations as of March 31, 2023 and $2,869 as of December 31, 2022, which are included in “Accounts payable and accrued liabilities” on our consolidated balance sheets. Our supplier financing programs are reported as operating or investing (when capitalizable) activities in our statements of cash flows when paid.Direct Supplier FinancingWe also have arrangements with suppliers of handset inventory that allow us to extend the stated payment terms by up to 90 days at an additional cost to us (variable rate extension fee). All payments are due within one year. We had $5,129 of direct supplier financing outstanding at March 31, 2023 and $5,486 as of December 31, 2022, which are included in “Accounts payable and accrued liabilities” on our consolidated balance sheets. Our direct supplier financing is reported as operating activities in our statements of cash flows when paid.Vendor FinancingIn connection with capital improvements and the acquisition of other productive assets, we negotiate favorable payment terms of 120 days or more (referred to as vendor financing), which are reported as financing activities in our statements of cash flows when paid. For the three months ended March 31, 2023 and 2022, we recorded vendor financing commitments related to capital investments of approximately $1,021 and $954, respectively. We had $5,003 vendor financing payables at March 31, 2023, with $3,531 included in “Accounts payable and accrued liabilities” and $6,147 vendor financing payables at December 31, 2022, with $4,592 included in “Accounts payable and accrued liabilities.”Let’s break it down.The disclosure under the first heading “Supplier Financing Program” is broadly similar to Verizon’s, albeit the amounts involved are multiples larger. AT&T’s more than $2.5bn of supplier financing outstanding at March 31 is over 3.5 times the equivalent at Verizon.But then, on top of that, AT&T had even larger amounts outstanding under so-called “Direct Supplier Financing” and “Vendor Financing” programmes. And the numbers get very large indeed when you sum up the liabilities under these three programmes, with $12.69bn outstanding as of March 31, 2023 and $14.5bn as of December 31, 2022:As with the supplier finance, AT&T is largely booking this stuff through its accounts payables line. We say “largely” because a chunk of the vendor financing is somewhere else, we presume because it has a longer term than a year, making them noncurrent liabilities. In contrast to its supplier financing, however, AT&T books repayments of the vendor financing through the financing activities section of its cash flow statements, along with debt and dividend payments, suggesting that in some ways it is even more finance-y:

© AT&T

This all presents an obvious question: aren’t these three forms of financing just different spins on supply-chain finance?Linguistically at least, “direct supplier finance” seems quite straightforwardly a variant of “supplier finance”, while the word “vendor” is also a synonym of “supplier”. Shouldn’t AT&T really lump them together and disclose it all as one double-digit billion dollar figure?After a long time playing spot the difference with the three descriptions, however, we noticed a subtle distinction: there is no mention of a “third-party financial institution” in the direct supplier finance and vendor finance disclosures.It suggests that AT&T, rather than a bank it has hired, pays these invoices.And for the purposes of the new US disclosures, that distinction matters. See this extract from FASB’s accounting standards update on “supplier finance programs”, our emphasis in bold:Supplier finance programs, which also may be referred to as reverse factoring, payables finance, or structured payables arrangements, allow a buyer to offer its suppliers the option for access to payment in advance of an invoice due date, which is paid by a third-party finance provider or intermediary on the basis of invoices that the buyer has confirmed as valid. Typically, a buyer in a program (1) enters into an agreement with a finance provider or an intermediary to establish the program, (2) purchases goods and services from suppliers with a promise to pay at a later date, and (3) notifies the finance provider or intermediary of the supplier invoices that it has confirmed as valid. Suppliers may then request early payment from the finance provider or intermediary for those confirmed invoices.On the face of it then, it seems that with no intermediary involved in AT&T’s so-called “direct supplier financing” and “vendor financing”, they do not meet FASB’s criteria for “supplier finance”.With these other sorts of arrangements, AT&T could either settle invoices early itself at a discount — booking the gain a bank would typically earn — or pay an interest-like fee to the supplier in exchange for pushing out the payment date. As one supply-chain finance specialist put it to FTAV: “You’re really putting your supplier in the role of a bank”.And this does not necessarily mean that banks are not involved at all. After earning a fee from AT&T in exchange for extending payment terms, a supplier could then turn around and factor those same outstanding invoices with a bank of its choosing. As long as it wasn’t AT&T’s bank that the telco had enlisted to acted as an intermediary, it wouldn’t technically be supplier finance under the FASB guidelines.FTAV asked AT&T about its supplier finance disclosures and it said the following: Supplier financing provides diversification and flexibility as part of our overall capital management strategies. Our disclosures are consistent with our focus to provide transparency for our stakeholders. Clouds on the VerizonHaving established that the new US accounting standards do not require companies to disclose financing arrangements with suppliers where they have not enlisted an intermediary to pay their invoices, it struck FTAV that other large US companies could engage in similar practices to AT&T and not disclose them at all.At this point, we decided to go back to Verizon. Did the company also engage in “direct supplier financing” and “vendor financing”? Verizon answered as follows: “Direct supplier financing” and “vendor financing” programs that you refer to are outside of the scope of the [Accounting Standard Update] for supplier finance programs. FASB’s Accounting Standard Update (ASU) 2022-04, applies to disclosure of supplier finance program obligations. Verizon’s disclosure in our Q1’23 10-Q includes a disclosure of outstanding amounts under such obligations, as well as a description of payment and other key terms of the program. Verizon does participate in Vendor Financing Arrangements, as disclosed under our “Liquidity and Capital Resources” discussion in the [management discussion and analysis], and additionally with our Cash Flow from Financing discussion, when material. Verizon does not have a direct supplier financing program.So, Verizon does not engage in direct supplier financing, but it does make use of vendor financing. And while the company says it discloses its use of the financing technique, in its last quarterly and annual results Verizon did not report the amounts outstanding, simply that its “external financing arrangements” include “vendor financing arrangements”.Verizon also only discloses vendor financing payments in its cash flow statement when they are “material”. While the telco disclosed “$320 million in payments related to vendor financing arrangements” in its 2021 annual report, there was no such disclosure in 2022, presumably because it did not deem that year’s payments as material. (In response to further questions about this, the company reiterated: “We only disclose when activity is material to Verizon.”) It is worth noting that Verizon’s use of vendor financing appears low compared to AT&T.While as recently as 2018 the former’s annual vendor financing payments outstripped the latter’s, Verizon’s have since dwindled while the AT&T’s have ballooned:It bears repeating: the numbers involved at AT&T are big. The $14.5bn of liabilities outstanding under its three payables finance schemes at the end of 2022 equated to over 10 per cent of its total debt.But at least AT&T now discloses all of this in one place. Other US companies could be paying their suppliers to extend payment terms with their shareholders none the wiser. With US publicly listed companies gearing up to report their second-quarter results in the coming weeks, FTAV recommends that interested analysts and investors probe a little further on what is and isn’t included in their supplier finance disclosures.The devil is, as ever, in the detail.* (As an aside, we are still disappointed that no one on the Treasury select committee asked Greensill’s highly paid boardroom adviser David Cameron to explain simply the mechanics of how supply-chain finance works. We will forever cherish, however, the former British prime minister’s statement that while “there were faults with the business . . . it doesn’t mean that the whole thing was necessarily a giant fraud”.) More

The writer is author of ‘Chip War’China’s emergence as the world’s largest auto exporter caught many people — including the biggest carmakers — by surprise. Cars used to be a rare type of manufacture in which western companies retained durable technological advantages. The transition to electric vehicles has given Chinese companies an opportunity to leap ahead, threatening to reshape trade flows in the process.The surge of Chinese cars into foreign markets poses two dilemmas that will complicate trade. The first relates to security. New cars feature dozens of sensors, complex software systems and semi-autonomous capabilities. Western leaders have only just begun to consider the security implications of fleets of foreign-made, sensor-stuffed cars on their roads. Beijing, by contrast, has imposed strict data localisation rules on Tesla — China is its biggest market outside the US — and banned Tesla’s cars from sensitive locations.Italy’s recent decision to limit a Chinese shareholder’s influence in Pirelli, a leading tyremaker, signals a change. The Italian government may be partly motivated by protectionism but it also cited Pirelli’s advanced Cyber Tyre, which collects and transmits driving data, as a rationale for curbing China’s influence in the company. Now even tyremakers are tech companies, the auto industry is unprepared for an intensified focus on security concerns about Chinese cars.The second challenge is to Europe’s industrial base. Legacy automakers, especially in the price-sensitive middle market, face tough competition. Chinese cars source components mostly from Asia, not from Europe; facing a surge of Chinese car imports, some European businesses are calling for help. Chinese EVs are high quality, though their price competitiveness has benefited from a decade of protectionism and government support totalling tens of billions of dollars annually. Western car companies are no strangers to bailouts or public ownership stakes, but the scale of support to China’s EV industry far exceeds other states’ generosity.History suggests that governments will be loath to let their companies lose auto market share. Japan’s success in selling to US consumers in the 1970s and 1980s caused tariff threats and currency disputes, leading American auto workers to bash Japanese cars with baseball bats. Tension was defused only when Japanese companies opened factories in the US.This time, the US is not bashing China’s cars but copying its methods, imposing major trade barriers such as the Trump-era 27.5 per cent tariff on imports of all Chinese vehicles. Now, Joe Biden’s Inflation Reduction Act provides generous subsidies for EVs that meet local content thresholds, excluding Chinese vehicles. In the face of these tariffs and subsidies, Chinese companies simply can’t compete in the US.But the EU’s car market remains open to imports. The continent’s EV subsidies have caused a surge of imports — partly because Chinese cars are cheaper and partly because European automakers were late in rolling out competitive EVs of their own. European nations are beginning to debate the wisdom of this approach. German automakers oppose protectionism lest Beijing respond by limiting their access to the vast Chinese market. France, however, recently announced environmental rules that, in practice, will ensure EV subsidies only apply to cars made in Europe. Senior French politicians call for dumping investigations — and even tariffs.News that Chinese EV makers now face overcapacity at home escalates these concerns. Nio, one of the country’s leading EV start-ups, cut prices by $4,200 per car in June, responding to slowing demand in China. From China’s playbook in sectors from steel to solar panels, domestic overcapacity may be addressed by ramping up cut-price exports.If so, the implications for trade would be wide ranging. Trade in car parts and finished autos exceeds $1tn annually. Alongside electronics, autos are one of the most complex and internationalised supply chains.Escalating auto trade tension would have an impact on another sector that has seen plenty of recent disputes: semiconductors. A typical EV has more than $1,000 of semiconductor content inside. The chips that manage EV power supply are mostly produced by western companies. If Chinese cars are locked out of foreign markets, will foreign chips be allowed in Chinese cars? Beijing would need only to point towards the IRA’s local content requirements as justification for further splintering trade in one of the world’s most globalised industries. More

Nearly 20 years ago, the economist Nicholas Stern, in a groundbreaking report for the UK government, memorably called climate change “the biggest market failure in history”. That sadly remains largely true. Emissions costs are still mostly loaded on to the planet rather than borne by polluters. The OECD says 60 per cent of carbon emissions from the world’s leading economies are completely unpriced, and only 10 per cent are taxed to a level that probably reflects the true cost of carbon.It’s an indictment of governments and their global institutions that all this time has not produced co-ordinated action. Divisions between and within rich and poor countries, institutional jealousies and an aversion among some big powers (particularly the US) to multilateralism have all prevented progress. Bizarrely, one of the more likely avenues for creating a global carbon pricing regime is a campaign of governments suing each other at the World Trade Organization, an institution whose credibility has been eroding for decades.The world’s response to climate change and carbon emissions is ineluctably bound up with trade. Without convergence in carbon pricing schemes, or border measures to charge imports for the untaxed emissions created while manufacturing them, there’s a high risk of carbon leakage as production shifts to dirtier economies.One of the biggest repositories of expertise on climate change and trade is the Paris-based OECD, which conducts research and hosts technical discussions among member governments. But the organisation’s actual policymaking function is essentially a forum for ad hoc negotiations rather than a permanent, binding legal framework, and its history as a club of rich countries weakens its legitimacy. The organisation made a promising breakthrough in 2021, for example, when governments struck a draft global deal to reduce tax avoidance by multinational corporations. But the agreement faces strong opposition in the US Senate and among developing countries (led by India, often the chief malcontent in global economic governance issues), which complain that it will reduce their revenues.The logical place for a binding settlement over carbon and trade would be just over three hours’ train ride away in Geneva at the World Trade Organization. But the WTO’s negotiation function, cumbersome and politically divided, has barely scored any major successes since its creation in 1995. Its member governments are now holding non-binding “structured discussions” on climate and trade.Where negotiation fails, litigation fills the vacuum. Perhaps the most substantive and immediate conversations are coming from governments (India in particular, again) threatening to bring cases against the EU’s carbon border adjustment measure to the WTO’s dispute settlement process for discriminating against their exporters.CBAM is being implemented this year and will start levying taxes from 2026. It provides incentives for countries to toughen their carbon regimes by charging imports the difference between their and Europe’s emissions prices, down to the level of individual producers.Brussels insists it will strive to make the CBAM WTO-compliant. On an optimistic reading this could mean the EU will tweak the border measures to stay legal if and when the rulings start to come down, eventually hammering out a system that commands some acceptance and encouraging other economies to adopt similar schemes. Those frustrated by the lack of EU-style carbon pricing elsewhere, such as the energetic US senator for Rhode Island, Sheldon Whitehouse, have actively encouraged the CBAM’s introduction. Protracted WTO litigation as a means of reaching consensus isn’t as ridiculous as it sounds. Although a 17-year litigation campaign seems farcical, the legal battle between the EU and US over subsidies to Boeing and Airbus between 2004 and 2021 did somewhat constrain trade-distorting handouts, as both sides made some effort to comply with successive rulings against them.The colossal difference, of course, is that the US has increasingly turned against the WTO dispute settlement regime. Joe Biden’s administration has maintained Donald Trump’s 2019 decision to paralyse the appeals stage of the process, forcing the EU and other countries to construct their own workaround system.The outcome of a WTO case would be highly uncertain. There are no direct precedents, and precedent is in any case not supposed to be binding in the system. If CBAM goes to WTO litigation there will be some fierce arguments about the EU taking into account developing countries’ compliance costs and its own historical emissions. Media reports in India seem to suggest Narendra Modi’s government is planning a carbon pricing regime that essentially charges Europe reparations for the industrial revolution.But apart from a collective fit of conscience among the world’s governments or the sudden emergence of binding negotiations, it’s hard to see what other mechanisms there are to spread the use of emissions controls. Building out a global carbon pricing regime through slow and iterative litigation in the politically contentious judicial wing of a troubled multilateral organisation is not exactly the kind of global governance the international relations textbooks recommend. But at the moment it’s basically all we’ve got. Meanwhile, the climate continues to deteriorate, the planet continues to degrade and the market continues to [email protected] More

“It’s like a declaration of war,” Robert Habeck, Germany’s vice-chancellor and economics minister, said last month. The object of his ire was not the Russian invasion of Ukraine nor Chinese military exercises around Taiwan. Instead, he was complaining about the raft of subsidies and tax breaks for manufacturers on offer in the US — Germany’s most important ally. “The [Americans] want to have the semiconductors, they want the solar industry, they want the hydrogen industry, they want the electrolysers,” Harbeck told a business conference. Ever since the Biden administration passed the Inflation Reduction Act and the Chips and Science Act for clean energy and tech last year, there has been a mutinous mood among some American allies in both Europe and Asia at the scale of the new US subsidies.What the US sees as a strategy to reverse deindustrialisation in deprived areas, allies have interpreted as a thinly veiled exercise in protectionism because it encourages companies to shift plants and customers to Buy American. Despite the mood of unity around the war in Ukraine, there have been calls to retaliate against Washington. “People were saying: let’s go to the WTO [World Trade Organization], make a big fuss,” says one senior official in Berlin. “I said: we’re in the middle of a war. Now’s not the time to pick a fight with our biggest ally.”After several decades when the US has used its influence at institutions such as the World Bank and the IMF to pressure governments to cut back subsidies, many have been quick to call hypocrisy over Washington’s new embrace of industrial policy. Europeans, in particular, are anxious about the competitive threat and the risk of seeing some of their industrial base migrate to the US. Yet as the dust has settled in recent months, the reaction has shifted from anger to a search for ways to catch up. The EU, Japan and South Korea have all introduced subsidies for their tech and clean energy sectors, in order to attract new investment or prevent more companies from shifting to the US. Europe, in particular, has adopted the politics of if you cannot beat them, join them. Or as Habeck put it last month: “If we don’t keep up, they’ll have them [the key industries] and we won’t. That’s the brutal reality.”Robert Habeck, Germany’s vice-chancellor and economics minister, visited Washington in February to discuss the consequences of the US’s Inflation Reduction Act © Leah Mills/Reuters“Where will all the future technologies — hydrogen, batteries, semiconductors — be based? That’s what’s being decided right now,” says Jens Südekum, professor of international economics at Düsseldorf’s Heinrich Heine University. “The US is taking the initiative on that and Europe has no choice but to respond. It can’t just do nothing.” For the US, the risk is not retaliation by an angry EU: it is that European governments become more reluctant to participate in the broader American project of forging an alliance of like-minded nations that is willing to push back against China. Throughout the cold war, the cohesion of the western alliance was regularly rocked by complaints about the US acting solely in its own economic interests, from Richard Nixon’s decision to abandon the link between gold and the dollar in 1971 to the interest rate hikes of the early 1980s. The Biden administration will have to work hard to prevent new economic frictions from undermining its principle foreign policy objective. “The new American industrial policy is first and foremost directed against China, and most people in Europe have finally begun to understand that,” says Südekum.Go westIt is easy to see why allied governments have been so rattled by the new US industrial policy. Many of the incentives are focused on businesses that assemble products in the US, which encourages companies to move production there. And not only do they qualify for the massive subsidies on offer from the Biden administration — they can also benefit from lower energy costs and taxes.Meyer Burger, a Swiss-based solar technology company that has three plants in eastern Germany, warned last month that it would build its new solar cell factory in the US rather than Germany unless Berlin provided more financial support. Gunter Erfurt, Meyer Burger’s chief executive, is full of praise for the IRA and the incentives it provides to clean tech companies. “Unlike us Europeans, the Americans have understood that solar technology is not just a commodity you can buy at the best price from any random provider, it’s at risk of becoming a plaything of geopolitics,” he says. “Everyone needs it for their energy transformation.”Even before the IRA came into force, there were signs that investment was flowing out of Germany. According to a study by the Cologne-based German Economic Institute, the gap between outbound investments by German companies and business investment into the country in 2022 was the largest on record. More than €135bn of foreign direct investment flowed out of Germany and only €10.5bn came in. Researchers at the institute cited Germany’s high energy costs and shortage of skilled labour for this, but warned that the IRA was likely to accelerate the trend. The impact is not just being felt in Europe. The IRA has prompted an investment spree by Japanese manufacturers with Panasonic, Toyota, Honda, Bridgestone and others announcing additional spending plans in the US. Last month, Mazda revealed that it was discussing a deal with Panasonic, which has battery plants in the US, to supply electric vehicle batteries, with officials admitting that the IRA was a consideration in starting the talks.South Korean companies have also been among the largest investors in green technologies in the US since the IRA was passed last year. According to Tim Bush, a Seoul-based EV battery analyst for UBS, by 2026 Korean battery makers will stand to collect an annual collective subsidy from the US taxpayer of upwards of $8bn from the IRA’s “advanced manufacturing production credit” alone. If you can’t beat themWatching these investments being outlined, the EU has spent this year trying to find ways to compete with the US. Brussels has been attempting to build its own plan for green manufacturing, on the principle that it cannot afford to sit on the sidelines while the US government embraces top-down green industrial policy.Analysts stress that European countries have already developed a green agenda that incorporates tens of billions of euros of subsidies. While the US regime offers subsidies worth $7,500 an electric car, for example, the average in the EU was already €6,000 per vehicle in 2022. Under the €800bn NextGenerationEU Covid-19 recovery programme, member states are required to commit at least 37 per cent of spending to the green transition.This comes on top of a regulatory framework that uses a carbon price, via the EU Emissions Trading System, to drive up investments in renewables and greener technologies. But it is also taking further steps. The European Commission last year relaxed its strict state-aid rules, giving member states more leeway to help their companies get through the turbulence triggered by Russia’s invasion of Ukraine. This was expanded in March this year to pave the way for more investment in Europe’s clean tech industry. The new “temporary crisis and transition framework” (TCTF) allows EU countries to provide subsidies to companies making things like solar panels, wind turbines, heat-pumps and the electrolysers needed to produce green hydrogen, as well as carbon capture and storage projects.It has already borne fruit. In May, the Swedish battery maker Northvolt committed to building its next factory in Germany after the government in Berlin promised to pump hundreds of millions of euros into the project.The decision was a huge relief for Germany. Northvolt had announced plans last year to build a factory in the northern state of Schleswig-Holstein. But in the ensuing months it indicated it was leaning towards the US market instead, citing the IRA, which it said was worth up to €8bn per battery factory. In the end, though, the government was able to use the carrot of generous TCTF funding to persuade Northvolt to stick with Germany. The TCTF framework is now being used to help solar companies, too. In late June, Habeck’s ministry requested expressions of interest in a new subsidy programme for companies planning to produce solar modules or components, or process the critical raw materials needed to make them.South Korea has responded to the US subsidies with a semiconductor package of its own, the so-called “K-Chips Act”. Passed in March, the legislation boosted tax credits for companies investing in manufacturing of “national strategic goods”, including semiconductors.Yeo Han-koo, a former South Korean trade minister now at the Peterson Institute for International Economics, described the US Chips act as a “catalyst” for Korean companies and the Korean government to “take bold action sooner”.The extent of the US subsidies means there are also likely to be a number of winners among European and Asian companies — especially those making the inputs for America’s coming green energy boom.

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“The IRA has unlocked trillions of dollars in investment and for us, that’s a net positive,” says Andrew Adair, trade adviser for North America with the VDMA, the main trade body for the German machine-building industry. Machine-builders and equipment manufacturers in particular are sitting pretty. Turbocharged by IRA subsidies, new plants are being built across the US: but “it’s very hard to build a factory there without European equipment and, especially, German machines,” says Adair. “The pie is getting bigger.”One beneficiary is ebm-papst, a Mittelstand company based in Mulfingen in south-west Germany that makes motors and ventilation systems. The IRA has fired up demand for the cooling fans the company’s produces for electric vehicle chargers and megapack battery storage systems.“The IRA is an opportunity for everyone,” says Mark Shiring, chief executive of the Americas for ebm-papst’s Air Technology Division. His company is in a “sweet spot”, poised to prosper from the planned rollout of high-speed EV chargers across the US. ‘Too little, too late’Will Europe’s response be enough to halt the slide of investment shifting to the US? Some worry the efforts so far are likely to be ineffectual. Businesses praise the relative simplicity of the US offer, which focuses on uncapped tax incentives targeted at manufacturers. By contrast, EU attempts to forge a convincing green industrial policy have been undermined by a patchy regulatory framework and complex processes for accessing multiple pots of money.Erfurt of Meyer Burger says the German solar subsidy announced in late June is a good first step but it is still not “cut and dried”. Europe, generally, was lagging behind the US. “Europe is just not the fastest in global terms,” he says. And even when the EU agrees on subsidies, “they are by no means at the same altitude as what the Americans are offering”.“The risk is that the EU’s response to the IRA will in the end be too little, too late,” says Südekum, the German academic. “The programmes are too complicated and are getting bogged down in details.” The EU, argues Jeromin Zettelmeyer, the head of the Bruegel think-tank in Brussels, has “been under pressure to produce quick responses to the IRA: these responses have for the most part been duds”. The loosening of the EU state aid rules was intended to empower member states to better compete with America’s massive tax credits, but it has fuelled concerns that the richest member states, led by Germany, would be able to boost their own industries while fiscally constrained states fall behind.A mooted German scheme to subsidise 80 per cent of the electricity cost for energy-intensive companies has further catalysed those concerns. As one EU diplomat points out, given the differing industrial makeups of member states, finding an industrial policy that suits all 27 is proving extremely difficult.“There is a fundamental problem at the heart of this, which is that if we continue to do industrial policy at the national level we are going to risk the single market in the end,” said Fabian Zuleeg, chief executive of the European Policy Centre think-tank in Brussels. But some EU diplomats are already drawing their own conclusions. “There’s a response but I’m not sure it was entirely coherent,” says one.The other dilemma for America’s allies is that they get pulled into a subsidy war. Nowhere have the risks of such a contest been more obvious than in the case of Intel’s big new German investment. The chipmaker had announced plans last year to invest €17bn in two new fabrication plants or fab in the eastern German city of Magdeburg. The German government had promised to subsidise the project to the tune of €6.8bn.Joe Biden and Intel CEO Pat Gelsinger at the groundbreaking for the company’s new semiconductor fabrication plant in Ohio last year © Manuel Balce Ceneta/APBut then Intel said it wanted more, citing higher energy and construction costs. In the end, the government agreed to raise the level of subsidy to €9.9bn, though Intel also announced it was increasing the investment volume from €17bn to €30bn.“There’s a lot of subsidy shopping going on at the moment,” says Moritz Schularick, head of the Kiel Institute for the World Economy in Germany. “Companies can say to politicians here: ‘we get more funding in the US’, and that can convince them to shell out even more money.”Many orthodox economists in Germany have expressed horror at the level of subsidies being offered to companies like Intel. Such support — and the mere suggestion of “industrial policy” — is an affront to German “ordoliberalism”, with its rejection of state intervention in the economy and its abhorrence of subsidies or tax privileges.Habeck admits that subsidies go against the grain of “pure economic theory”. But the Europeans had no choice but to match the huge incentives on offer in the US and China, which are attracting billions of dollars in investment. “We have to decide: do we continue to act according to what’s in our textbooks?” he told the Süddeutsche Zeitung at the end of June. “If we do, we won’t have any of the key industries of the future.”Arguing over ChinaThe biggest risk for the US is not retaliation by angry allies, but that the legislation could backfire and drive Europe further into the hands of China. That, at least, was the warning from officials including Valdis Dombrovskis, the commission’s trade chief, when the EU-US spat was at its height late last year. The US has been attempting to counter such concerns by talking up the prospects for collaboration with its allies on developing new supply chains, including via the mooted critical minerals agreement it has been discussing with the EU. European Commission president Ursula von der Leyen met President Joe Biden in March to try to defuse tensions over US green energy subsidies © Mandel Ngan/AFP/Getty ImagesBut as those negotiations with the Biden administration drag on, the EU has been seeking to develop a distinctive approach to its trade with China. At its latest summit, the EU stressed that while it wants to “de-risk and diversify”, it “does not intend to decouple or to turn inwards” — drawing a clear distinction with the language commonly used in the US. That reflects a recognition of the deep integration between the EU and Chinese economies in areas including renewables. China for example last year exported 86.6GW of solar panels to Europe, a 112 per cent increase on 2021’s figure, according to InfoLink Consulting.“If we are going to hit our 2030 [climate] targets we need China,” says Jacob Kirkegaard of the Peterson Institute. Rather than railing against unfair subsidies, whether they are being doled out in the US, China or Europe, he says, maybe this is a moment to accept them as a necessary part of an urgent drive to lower greenhouse gas emissions. “We in the EU have decided the green transition is the biggest issue we face, and rightfully so,” Kirkegaard adds. “We are in a planetary emergency.”Additional reporting by Christian Davies in Seoul More

While central banks in developed countries wrestle with stubbornly high inflation, China has the opposite problem — the world’s second-largest economy is flirting with deflation.Beijing revealed this week that consumer prices were flat in June compared with a year earlier while producer prices plunged at the fastest pace since 2016. That compares with a US inflation rate that hit 9.1 per cent in June last year and was at 3 per cent last month despite multiple interest rate increases by the Federal Reserve. Even Japan, once almost a byword for deflation, boasted a relatively racy inflation figure of 3.2 per cent in May. Developed economies were hit particularly hard by soaring energy and food prices as Russia launched its full-scale invasion of Ukraine last year, but price controls on energy in China shielded it from the worst of those fluctuations. Instead, the country is at risk of deflation because of low consumer demand and private investment as the economy emerges from draconian zero-Covid controls, economists said.With China poised to unveil its second-quarter gross domestic product figures on Monday, economists will be closely watching for clues about the underlying health of the economy and what policymakers might do to keep the country’s post-Covid recovery on track.“The main point is that . . . domestic demand is really weak and that explains the very negative sentiment,” said Alicia Garcia Herrero, chief Asia-Pacific economist at Natixis.

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Why is China bucking the global inflationary trend?China was the last large economy to fully emerge from the pandemic, throwing off its Covid-19 controls in December last year.Like other countries, China sought to counter the pandemic’s negative economic effects by keeping monetary and fiscal policy accommodative. In 2020, the government issued bonds worth Rmb1tn ($140bn), ran a fiscal deficit of 3.6 per cent of GDP and cut policy interest rates by 30 basis points. In 2022, it channelled another Rmb1.4tn in “quasi-fiscal funding” through state banks, according to Citi research. It also allowed greater local government bond issuances and cut rates by another 20bp.Beijing’s fiscal stimulus, however, was mostly channelled to areas such as infrastructure spending and businesses in the form of tax reductions, cuts to compulsory social security payments on salaries and other measures aimed at preventing job losses.The US, by contrast, launched a much grander fiscal and monetary stimulus plan, with American consumers receiving part of the bounty in direct payments and jobless benefits.

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The US and other western countries also suffered supply-side constraints as people left the workforce and supply chains were disrupted. In China, the world’s factory, there were fewer supply chain problems. Chinese citizens were locked up for longer in their homes and businesses closed, leading to greater unemployment and deep damage to household balance sheets. The property collapse also hit commodity prices, reducing producer price inflation.At the same time, many local governments emerged from the pandemic drowning in debt. The private sector was left with overcapacity and, sensing the weak consumer demand, an unwillingness to invest.“China is on the brink of a self-fulfilling ‘confidence trap’ as the initial reopening impulse starts to fade,” Citi analysts wrote in a recent note.

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What could deflation mean for China?The danger for policymakers is if the deflationary trend becomes entrenched in consumer and business expectations, analysts said. Companies will further hold back investment as profits dry up while consumers will spend less as they worry about their job security and further falls in property prices.There is evidence that the property sector, after stabilising early in the year, is again on a downward track. Transaction volume by floor space contracted 19.2 per cent year on year in June from a decline of 3.5 per cent in May, Nomura said based on a sample of 330 cities covered by the data service Wind.Economists warned of further potential weakness in consumer prices. Even though China’s headline inflation rate was flat in June, core inflation — which strips out volatile food and energy prices — declined 0.1 per cent compared with a month earlier, “which could point to a loss of momentum in the consumption recovery”, HSBC said. Food prices also remain volatile: falling pork prices, for instance, affected consumer prices in June as strong supply met weak demand. 

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While inflation is expected to rise slightly in the coming months because of a low base effect, many analysts said the government needed to step in with more support for the economy to anchor expectations.“Further policy easing on housing and infrastructure, which could arrive in the coming weeks, will be crucial to stabilise aggregate demand,” Morgan Stanley analysts wrote in a research note.What help is on the way?Almost on cue after the release of weak consumer price data this week, the government extended a package of credit-related measures for developers aimed at arresting the fall in housing prices.The government has already reduced policy interest rates by 10bp this year, and many expect further cuts in the third quarter to sustain credit growth. Analysts are awaiting a meeting of the Communist party’s ruling body, the politburo, this month and expect more measures.

Most of them anticipated any support to be more incremental — Beijing lacks the fiscal room and perhaps the inclination to launch the “bazooka” stimulus packages of the past. But there is a consensus even among some former government officials that more needs to be done.Former finance minister Lou Jiwei said the government should expand this year’s fiscal deficit by Rmb1.5tn-Rmb2tn in order to provide subsidies to small and medium-sized enterprises. The measures, along with the removal of restrictions related to mortgages and homebuying, were needed “to bring economic recovery back on a more solid track”, state media quoted him as saying. More

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