Aurelia Butler

Europe’s top financial regulators have issued an unprecedented warning about “severe risks to financial stability” after concluding Russia’s invasion of Ukraine could create a toxic combination of an economic downturn, falling asset prices and financial market stress.The European Systemic Risk Board, which is responsible for monitoring and preventing dangers to the region’s financial system, issued the alert after meeting last week and deciding the energy crisis triggered by the war in Ukraine had put the financial system in a precarious position. This is the first “general warning” about risk the ESRB has issued since its creation in 2010 on the eve of the eurozone sovereign debt crisis. The authority, which is chaired by European Central Bank president Christine Lagarde, called on regulators in the 30 countries it oversees to prepare for a potential crisis by requiring the financial institutions they supervise to build up bigger buffers of capital and provisions that can absorb losses.The ESRB’s warning was agreed on September 22, several days before the new UK government’s unorthodox fiscal plans caused turmoil in financial markets and forced the Bank of England to intervene by buying bonds. People briefed on ESRB discussions said the UK’s problems were not part of the discussions, however they acknowledged that they were likely to now be an additional worry for regulators in Europe.Concerns about the health of Europe’s financial system have increased since the Ukraine conflict pushed energy prices up, driving inflation to multi-decade highs, prompting central banks to raise interest rates aggressively and triggering a sell-off in bond and equity markets. “Rising geopolitical tensions have led to an increase in energy prices, causing financial distress to businesses and households that are still recovering from the adverse economic consequences of the Covid-19 pandemic,” the ESRB said. “In addition, higher-than-expected inflation is tightening financial conditions.”It identified three key sources of systemic risk: “The deterioration of the macroeconomic outlook, risks to financial stability stemming from a (possible) sharp asset price correction and the implications of such developments for asset quality.”The housing market — a recurring concern for the ESRB — was still a potential weakness, it said. “Rising mortgage rates and the worsening in debt-servicing capacity due to a decline in real household income can be expected to exert downward pressure on house prices and lead to a materialisation of cyclical risks,” it warned.It also listed rising default risk in the commercial property sector, cyber attacks on financial institutions and the increased cost of high government debts as interest rates rise among other areas of concern.Europe’s financial system has come through the pandemic relatively unscathed, but that was in large part due to significant support for households and businesses from governments and central banks. The ESRB warned the probability of “tail-risk scenarios” had risen since the start of the year, pointing out that house prices had been increasing at rapid rates for years and overall debt levels in Europe had surged by almost a fifth since early 2020 to €27.5tn.  More

This spring, just after Russia’s invasion of Ukraine, Washington’s Institute of International Finance made a bold and idiosyncratic prediction: the euro was about to weaken dramatically from its $1.11 level because the region was heading for a current account deficit.Not many investors agreed. Data from the Commodity Futures Trading Commission suggests that there was a net “long” speculative position in the markets then — in other words, investors were betting the currency would strengthen — because the European Central Bank was raising interest rates.But the euro is now worth $0.98, and Europe’s traditional trade surplus has indeed turned into a current account deficit, due to the soaring cost of energy imports and falling industrial exports.The IIF’s projections about sterling have been equally prescient. In recent months, Robin Brooks, IIF chief economist, has also warned that the pound looked overvalued at its then $1.35 level, since markets were ignoring that the UK current account deficit had quietly risen above 8 per cent, from the 3 per cent levels seen in recent years. This week the British pound duly crashed to near-parity with the dollar, after the UK government unveiled a surprise tax-cutting plan. “These moves [in the euro and sterling] aren’t irrational or overshooting,” argues Brooks. “The fair values of both have shifted to reflect higher energy costs and far weaker trade balances.”Indeed, Brooks thinks that at present levels “the euro is still 10 per cent overvalued [and] the pound is 20 per cent overvalued”. Yikes.Moreover, his model suggests that the Turkish lira and New Zealand dollar are also overvalued (by 15 and 22 per cent respectively), while the Chinese renminbi, Brazilian real and Norwegian krone are undervalued by 11, 13 and a whopping 47 per cent.Investors should take note. Some foreign exchange analysts might mutter that this type of analysis looks very retro. Economics 101 has always argued that current account balances affect currency values because they determine the degree to which a country has to attract external financing.However, the trading models used by asset managers in the recent era of ultra-loose monetary policy have typically focused on other issues shaping capital flows. Relative interest rates, say, have tended to dominate debate, particularly since investors have been engaging in carry trades (borrowing cheaply in one currency to invest in higher-yielding assets in another). And “the carry trade has had a sudden resurgence in performance”, as the GMO group recently noted. (The fair value models it uses, which give less weight to current account balances, imply that sterling and the euro are under — not over — valued.) Then there are the issues of political risk and safety. The IIF’s analysis suggests that the dollar was overvalued, given its current account deficit. But it has actually strengthened this year since, as my colleague Martin Wolf has pointed out, the dominance of American capital markets — and currency — has made it a safe haven. But while the behaviour of the dollar shows that it is a mistake to treat currency analysis as anything other than an art, not a science, the sterling saga shows something else: it is even more dangerous to ignore economic gravity. After all, arguably the best way to frame this week’s sterling crash is to think of the Wile E Coyote cartoon character. Just as that animated figure runs off a cliff and keeps pedalling at the same height — until he looks down and panics — investors have spent most of the year acting as if the pound were destined to stay elevated, because they trusted British policymaking and rising UK rates. Now economic gravity has taken hold.If you believe in the mean regression principle which underpins many trading models — that asset prices eventually resort to a recent mean after a wild swing — then it is possible to hope that sterling’s slump will be temporary. But if you think that an 8 per cent current account deficit puts the UK in a new era, past models may not apply. Either way, investors should ponder if there are other places where a reckoning might occur. The IIF chart highlights strains in the currency world. Debt data offers additional clues. There has been remarkably little public debate in recent years about the astonishing fact that global debt has doubled since 2006 — and tripled since 2000. That is because interest rates were ultra-low. But now rates are rising and the fiscal burden in many countries is soaring amid energy subsidies and pandemic spending (and, in the UK, unexpected tax cuts). There are also signs that investors are getting more nervous: quite apart from this week’s visible Treasury and gilt market tensions, JPMorgan reports that global investors now plan to allocate a mere 17 per cent of their portfolios to bonds. This is a remarkably low level, given they have been overweight for the past 14 years.This does not mean that investors should panic. But they should ask themselves why they ignored the data in charts such as the IIF reports for so long. Sometimes economic gravity matters. Cheap money will not always keep Wile E Coyote [email protected] More

German inflation soared to double-digit levels for the first time in more than 70 years, underlining the precarious state of Europe’s largest economy, which leading economists warned could shrink by up to 7.9 per cent next year in a worst-case scenario.Chancellor Olaf Scholz responded to soaring energy costs on Thursday by announcing plans for a €200bn cap on gas prices, which he described as a “defensive shield” to be financed by extending an off-balance sheet fund set up to provide aid during the coronavirus pandemic.Consumer prices in Germany rose 10.9 per cent in the year to September, accelerating from 8.8 per cent in August, according to a flash estimate published by the federal statistical agency on Thursday. It is the first time German inflation has reached double-digit levels since 1951 and the increase is expected to lift overall eurozone inflation to a new record of 9.7 per cent when those figures are released on Friday.“Inflation is running red hot in Germany,” said Carsten Brzeski, an economist at Dutch bank ING, adding that it was “hard to see” how the European Central Bank could not raise interest rates by 0.75 percentage points for a third consecutive time at next month’s meeting.The increase in German prices — which rose 2.2 per cent month on month — was driven by the expiry of temporary measures to shield households and businesses from the impact of high prices, such as a fuel duty cut and a subsidised €9 monthly train ticket. Energy prices rose 43.9 per cent in the year to September, accelerating from 35.6 per cent growth in August, while food prices surged 18.7 per cent against 16.6 per cent a month earlier. Services price growth accelerated to 3.6 per cent from 2.2 per cent.Russia’s decision to cut gas supplies to Europe after its invasion of Ukraine has plunged Germany into its worst energy crisis since the second world war. Soaring gas prices have forced many companies to reduce production or even shut down entirely, while private households are preparing for a huge increase in heating bills. Germany’s top economic institutes said the country would expand by 1.4 per cent this year, contract by 0.4 per cent in 2023 and grow by 1.9 per cent in 2024. But they also warned the economy could shrink by 7.9 per cent next year in the event of an unusually cold winter and the introduction of gas rationing in industry.“If we get a much colder winter gas consumption will grow significantly, which will increase the likelihood of a gas shortage,” said Torsten Schmidt of the Leibniz Institute for Economic Research. “That will have more of an impact on GDP than we’ve assumed in our forecast.”The institutes said that, based on the median of their model simulations, Germany will not run out of gas this year and next, though the supply situation would remain “extremely tight”. They said that “this will mean a permanent loss of prosperity for Germany”. The “heightened risk” of gas rationing and shortages could be avoided if consumption was reduced by 20 per cent and imports were increased, but the institutes warned of a “massive drop” in GDP at the start of 2023 and 2024 if the country fails to sufficiently curb gas use. The forecast was produced by the Ifo Institute in Munich, the Kiel Institute for the World Economy, the Halle Institute for Economic Research as well as the Leibniz institute. The prognosis marks a radical downward revision of the institutes’ spring forecast when they predicted growth of 2.7 per cent this year and 3.1 per cent in 2023. “This revision mainly reflects the extent of the energy crisis,” they said, adding that the value of output in 2022 and 2023 would be €160bn lower than expected in the spring.Schmidt said private households were bearing the brunt of higher energy prices and facing a “huge loss in purchasing power”. Most companies were, in contrast, managing to cope with the energy crunch, he added.As temperatures fall in Germany, gas consumption by households and businesses rose sharply in the past week to 14.5 per cent above the average over the past four years, the federal network agency said on Thursday. Klaus Müller, head of the agency, said the change was “very sobering” while adding that the situation could rapidly change.The institutes said inflation would rise to 8.8 per cent next year, slightly higher than this year’s level of 8.4 per cent, though it would decline to 2.2 per cent in 2024. More

Strong demand for personal transport has led to steady sales of both new and used cars in the United States so far, but rising interest rates and higher car prices are starting to upend that trend. “We believe a number of macroeconomic factors impacted our second-quarter unit sales performance, such as vehicle affordability challenges that stem from widespread inflationary pressures, as well as climbing interest rates and low consumer confidence,” CarMax said. Auto research firm Cox Automotive, which tracks U.S. vehicle market trends, on Wednesday cut its forecast for new and used vehicle sales on worsening consumer sentiment. Consumers are pulling themselves out of the purchase process as rising interest rates and high vehicle prices make monthly payments unaffordable, said Cox Automotive Chief Economist Jonathan Smoke.CarMax’s quarterly sales and profit miss and bleak commentary were a drag on shares of rivals AutoNation Inc (NYSE:AN) and Lithia & Driveway, both of which fell about 4% each.CarMax, whose shares were set to open at more than a two-year low on Thursday, reported a profit of 79 cents per share, that fell well below the average analyst estimate of $1.39 per share, as per Refinitiv data.Revenue was $8.14 billion and came in below the expectation of $8.54 billion, as its sales of retail used units fell 6.4%, while comparable store sales were down 8.3%.Ford Motor (NYSE:F) Co’s shares tumbled last week after the automaker said it was experiencing higher inflationary pressures.The automaker, however, kept its full-year adjusted EBIT forecast even as the overall economic picture darkens. More

BERLIN (Reuters) -German Chancellor Olaf Scholz set out a 200 billion euro ($194 billion) “defensive shield” on Thursday to protect companies and consumers against the impact of soaring energy prices.Europe’s biggest economy is trying to cope with surging gas and electricity costs caused largely by a collapse in Russian gas supplies to Europe, which Moscow has blamed on Western sanctions following its invasion of Ukraine in February.”Prices have to come down, so the government will do everything it can. To this end, we are setting up a large defensive shield,” said Scholz, outlining the package.Under the plans, which will be financed with new borrowing, the government will introduce an emergency price brake on gas and electricity and scrap a previously planned gas levy on consumers to avoid further price increases Nuclear plants in southern Germany, previously due to close by the end of this year, will be able to keep running until spring 2023.Berlin has suspended its limit on new debt of 0.35% of gross domestic product this year. Finance Minister Christian Lindner has previously said he wants to comply with the limit next year.Lindner said on Thursday Germany would finance the relief package by taking on new loans, adding that the country’s public finances were stable.”We can put it no other way: we find ourselves in an energy war,” said Lindner, adding:”We want to clearly separate crisis expenditure from our regular budget management, we want to send a very clear signal to the capital markets.”The gas levy, which had been due to come into effect from Saturday and remain in place until April 2024, was conceived with a view to helping utilities cover the cost of replacing Russian supply.However, the need for the levy came into question after the government’s decision to nationalise Uniper, Germany’s biggest Russian gas importer.($1 = 1.0326 euros) More

The modern semiconductor industry is a manufacturing miracle. In 1961 a state of the art computer chip contained just four transistors. Such has been the industry’s extraordinary innovation since then that the latest graphics chip from Nvidia contains 76bn. According to a calculation by the historian Chris Miller, the global chip industry manufactured more transistors last year than the combined quantity of all other goods produced by all other industries in all of human history.The astonishing expansion of the semiconductor industry, which powers everything from smartphones to ballistic missiles, has been mostly driven by the ingenuity of chip designers and the dynamism of the market. But, given its strategic importance, it has been periodically stimulated and steered by governments. The risk today is that geopolitical tensions between the US and China threaten to rip apart this intricate, and highly interconnected, sector. The possibility is that intensified competition might yet incentivise further innovation.Since 2020, the US has imposed a “chip choke” on China, banning the export of leading edge semiconductor technology to Beijing. In response, China has been pouring billions into developing its own chips sector. Costs are increasing for the global industry and production efficiencies are declining as existing supply chains are rewired. But national security now overrides economic logic. This stand-off is already inflicting pain on semiconductor companies in countries allied to the US, especially in East Asia, where so much manufacturing capacity is clustered. The Taiwanese and South Korean companies that dominate the industry are reluctantly being forced to choose between Washington and Beijing. Without China, they lose access to one of their biggest markets, but they are also now facing increasing competition from the US itself. Passed in July, the US Chips Act, which provides $52bn of subsidies to the national semiconductor industry, has signalled Washington’s determination to revive domestic manufacturing.This week, South Korea’s science minister warned that a “sense of crisis” was gripping his country’s much-valued semiconductor industry amid the intensifying global chip war. In an interview with the Financial Times, Lee Jong-ho expressed fears that the competitiveness of South Korea’s chip sector was threatened by both Washington’s campaign to lure the country’s manufacturers to the US and Beijing’s massive state support for China’s chip sector.According to a report by New Street Research, governments in China, the US, the EU, Japan and India have collectively promised $190bn of subsidies over a decade as they seek to localise manufacturing capacity. The sheer scale of state intervention is likely to result in overcapacity in some segments, which could trigger future dumping and trade disputes. But the wall of money may also amplify the wild cyclical swings that have historically characterised the industry.Two years ago, the Covid pandemic disrupted global supply chains, causing severe chip shortages in the car industry and leading to a subsequent surge in investment. This year, the slowdown in the global economy is damping demand. Gartner predicts that semiconductor revenues will fall by 2.5 per cent to $623bn next year. Governments may be pouring money into the sector just at the point when excess capacity comes on stream and prices tumble.However, Pierre Ferragu, managing partner at New Street Research, says it will take several years before subsidies feed into additional capacity, giving manufacturers time to calibrate supply. “I do not think it will affect the cycle a lot in the long run. It will be a positive for the industry,” he says.This fresh wave of investment might well stimulate innovation. “My guess is that when we look back at the Chips Act in 10 years’ time we will think the money spent on manufacturing investment was not as important as the money spent on R&D,” says Miller, author of Chip War, a new book on the semiconductor industry. “Whereas companies tend to have a two- to three-year time horizon, governments have a 10- to 15-year time horizon.”The huge remaining unknown overshadowing the industry is whether China tries to take over Taiwan. Tsai Ing-wen, Taiwan’s president, argues her island is protected by a “silicon shield”, considering how vital its leading-edge chips are for the global economy. But the US is showing how much it prizes national security over economic efficiency. It would not be a surprise if one day China makes a similar [email protected] More

On Wednesday in Tokyo, in what greyer heads around the table may have relished as a historic role-reversal, US vice-president Kamala Harris gathered top executives from Japan’s semiconductor sector to discuss the implications of the US’s industry-boosting $280bn Chips and Science Act. Fiscal “plan-splaining” does not get much more poignant: 40 years since Japan As Number One was a bestseller and 30 years since Rising Sun was a blockbuster, here was the America of market forces sitting down with Japan Inc to tell it all about targeted industrial policy. A day earlier, the US trade ambassador Katherine Tai had also painted a picture of shifting times. The US, she told the FT, was now actively co-ordinating trade policy and domestic investment programmes in deliberate contrast with its traditional, single-minded prioritising of maximal liberalisation. So might this shift — industrial policy’s ascent from curse word to the new Washington mantra of strategic competition — be the ultimate symptom of American Japanification?The setting of Wednesday’s meeting makes it a very tempting thesis. Harris was holding the discussions on the US’s state-turbocharged semiconductor ambitions just a few hundred metres away from Japan’s Ministry of Economy, Trade and Industry. This is the successor to the Ministry of International Trade and Industry, or Miti, that authored the story of Japan Inc and oversaw the combination of industrial and trade policies that appeared to make Japan so unstoppable in the 1970s and 1980s. Her roundtable participants were from companies that had, in their heyday, been favoured by a government that saw them as critical to the national interest. Japan Inc’s was a narrative propelled by genuine policies and a willingness of Japan itself and the outside world to believe in their effectiveness. The Japanese government really did direct resources to particular industries, semiconductors among them, in the quest for greater international competitiveness. To those (particularly the US) whom this strategy comprehensively outcompeted, the idea of a conspiratorial state-corporate complex (with its convenient “Japan Inc” terminology) was an easily grasped concept to either laud or lambast. However critical the roles of liberalised world trade and fundamental Japanese business skill may actually have been, Miti and industrial policy hogged the limelight. Throughout the periods of both Japan Inc’s success and subsequent decline, the US position seemed clear. However enviable the trophies held by Japan, it was anathema to talk positively about a Japan Inc-style industrial policy as an option for the US. To do so, in theory, would be to admit to a range of desirable outcomes that market forces alone might never achieve, let alone guarantee. Such an admission, though, now feels implicit — not just in the chips act itself, but in the bipartisan support it attracted. The prevailing narrative in Washington on China is alarm at its surging industrial power. But while the creation of an overt industrial policy for America may be driven by pragmatism, giving pragmatism free rein, arguably requires at least a form of ideological shift. Belatedly, perhaps, the magnitude of the perceived China threat has caused the US to decide that it cannot afford the laissez-faire approach to private sector decision-making when it affects the national interest.This is why Japanification is probably not the right word here. Whatever the front-of-house rhetorical taboos around industrial policy may have been, the reality is that Washington has been running versions of them for years — most visibly under the framework of the military-industrial complex. When concerns over critical technology have intensified, this has provided a mechanism for directing investment in a way that the markets might not have on their own. For all its “business is war” sloganeering during the 1980s, the overwhelming desire of Japan was to outperform its great rival in growth and market share. Its industrial policy was a reflection of that, the US understood it as such and did not, despite books like the 1991 classic The Coming War With Japan, feel the need to create industrial policy of its own to offset that. The situation with semiconductors in the 2020s is very different. The perceived threat from China is not outperformance in business, but, in the longer term, the opening of a technological gap that cannot easily be narrowed. The immediate rival on chips may be Taiwan but America’s new industrial policy is crafted around fears of a greater foe. [email protected] More