Aurelia Butler

European corporate leaders are becoming detached from their Chinese operations and less tolerant of Beijing’s diktats as business confidence plummets in the world’s biggest consumer market and factory floor.The warning from the EU Chamber of Commerce in China comes as strict border closures, which have persisted for more than two years under President Xi Jinping’s stringent zero-Covid policy, extend into the third year.“China operations are becoming increasingly isolated due to China-based staff, both foreign and Chinese, being unable to travel to European headquarters for information exchanges, networking, training and the sharing of expertise,” the chamber said in a report released Monday.“Senior decision-makers from HQ are also being deprived of first-hand China experience, which is resulting in less understanding of — and therefore less tolerance towards — China. The loss of diversity among the workforce in China will also impact innovation.”The chamber’s warning highlighted the risks of long-term consequences for international business from Xi’s policy of eradicating the virus, with snowballing economic and social costs from snap lockdowns, closed borders and fastidious mass testing.It also reflected rising fears and greater “attention in boardrooms” over worsening geopolitical tensions stemming from Russia’s invasion of Ukraine. Beijing has refused to join international condemnation of the war and has provided support by bolstering Vladimir Putin’s battered economy.China’s economy is wobbling on the edge of a rare recession this quarter after its zero-Covid policy forced hundreds of millions of citizens into partial or full lockdowns and caused widespread supply chain disruption.The EU chamber report, which drew on a flash survey from late April and an earlier survey, said that more than 90 per cent of its respondents were affected by port closures, road freight decreases and the spiralling costs of sea freight.Almost one-quarter of European companies in China are reviewing their investments.According to the survey, 23 per cent of the region’s companies are “considering shifting” current or planned investments outside China’s borders.Seven per cent of European companies operating in China said they were reviewing investments directly because of the war in Ukraine, and one-third believed the market had become less attractive since Moscow’s invasion in February.But it is not just European companies that are considering decoupling from China and stoking concerns about deglobalisation.

More than a quarter of US manufacturers in China are moving production of their global products out of the country while accelerating localisation of their supply chains inside China, according to a survey published by the American Chamber of Commerce in Shanghai last week.Nine in 10 US companies across the manufacturing, consumer and services sectors have slashed their revenue forecasts for China this year.More than three-quarters of the European companies surveyed said that the zero-Covid measures had also diminished China’s attractiveness as an investment destination. Businesses highlighted longstanding grievances such as forced technology transfers, unfavourable treatment compared with Chinese rivals and ambiguous rules and regulations.However, the survey, which was conducted with German consultancy Roland Berger, also illustrated that even after decades of booming growth, some European companies still predicted a “great deal of potential” in the Chinese market.“The rewards of staying the course and navigating the storm are plain to see,” the report said, pointing out that before the Omicron outbreak and war in Ukraine, about 30 per cent of companies planned to increase their shares in local joint ventures. More

Good morning. In response to Friday’s letter on the persistent strength of the US economy — outside of the housing market — a reader made an obvious point, one we should have made ourselves. The economy’s resilience, though it sounds like good news, is going to make the Fed’s job a lot harder. It might have to tighten very aggressively to get demand below supply. But the Fed can hope for help from markets, as we discuss today. Email us: [email protected] and [email protected] effectsThe bear market in risk assets has been caused, in some part, by fear of a Fed-induced recession. But the causality can run the other way, too: if there is a recession, the bear market will probably be one of the causes. Lower stock, bond and crypto prices make people feel poorer, so they spend less, making the economy smaller than it would otherwise be. For the Fed, at the moment, this is welcome news. They need growth to slow. But how much of a wealth effect can they expect? Might they get more help than they want?Desmond Lachman, an economist and fellow at the American Enterprise Institute, pointed this out in response to last week’s letter about the economic slowdown:The stock market rout of around 25 per cent has caused around $10tn in US household wealth to evaporate. In addition, at least $3tn in bond and $2tn in cryptocurrency wealth has been wiped out by the rout in those markets . . . On the assumption used by the Federal Reserve that a $1 sustained destruction in wealth leads to a 4-cent decline in consumption, if sustained, the recent loss in wealth could reduce consumption by almost 3 percentage points of GDP.That last number struck me as pretty large, so I tried to reproduce it. Here is what I found:According to the Federal Reserve’s distributional accounts, American households held $42.2tn in equities and mutual fund shares as of the end of 2021.The Wilshire 5000, an index that captures virtually all publicly traded US shares, is down 25 per cent since year-end 2021 — a moment that happily coincides almost exactly with the top of the market. The Bloomberg long-term Treasury total return index is down by almost exactly the same amount. So making the simplifying assumptions that (a) Americans are exposed mainly to US stocks (b) Americans get their bond exposure through mutual funds, and (c) returns on that bond exposure has roughly tracked long-term Treasuries, we can assume that household portfolios have lost $10.6tn in value this year. A paper from the Federal Reserve looking at fluctuations in household wealth and spending during the 1990s market boom finds that “groups of families whose portfolios were boosted the most by the exceptional stock market performance over the latter half of the 1990s are the same groups whose net saving flows fell the sharpest from 1995 through 2000,” and that “The [resulting] movements in net worth and saving are consistent with a wealth effect in the range of 3-1/2 to 5 cents on the dollar that applies to all families in the economy.”So assume, conservatively, that every dollar lost in markets translates to 3.5 cents of lost spending. That comes to $370bn in lost spending, or about 2.6 per cent of consumer expenditures or 1.8 per cent of GDP. The total market capitalisation of crypto assets has fallen from $2.9tn to $835bn, according to CoinMarketCap. This translates to another $73bn in lost spending, and another third of a per cent or so of GDP.So for a first, conservative estimate, the bear market’s impact on spending could amount to a 2 per cent drag on GDP.That’s a lot! Recall that in the first quarter GDP grew 2.6 per cent, once some odd fluctuations in inventories and net imports are stripped out. Forecaster consensus calls for GDP to grow 1.8 per cent for the rest of the year, with consumer spending growing a bit faster than that, with the basic pattern to persist for 2023. How much of a negative wealth effect is built into those forecasts I have no idea. It’s a very rough and ready estimate, though. Sensitivity of spending to loss of wealth likely depends on hard-to-measure psychological factors. For example, it must matter how much people are counting on the wealth they have gained in markets, as opposed to thinking of it as a windfall. Did households treat their sudden crypto gains as “found money” rather than hard-earned savings, and therefore change their spending patterns less in response to their appearance and evaporation?About 20 years ago, a Fed board member, Edward Gramlich, made the point that in theory, the impact of stock market wealth on consumption should depend on whether stock prices rose because profits rose, or because discount rates fell (or what amounts to the same thing, price/earnings multiples rose):Suppose, for example, that stock prices increase because of a rise in expected profits, say from a spurt in productivity. An individual household that owns stocks will have higher wealth and will want to consume more, just as predicted by the wealth effect . . . [if instead] stock prices increase because households are applying a lower discount rate to future profits [then whether] an individual household will want to consume more is unclear in this case. Intuitively, households are simply discounting the same stream of profits at a different rate; so it is not obvious that they are truly better off and should increase their consumption.I would make sense of this point intuitively as follows. If my stocks have gone up because of strong economic growth, the gains make sense to me. I’m an owner of growing businesses in a growing economy. If they go up because of multiple expansion, that feels chancy. I trust the new wealth less, and might be less inclined to let it change my spending patterns, as a result.I really am not sure if the source of market returns matters to spending or not. But it is a particularly important question right now. During the 2009-2021 bull market, the S&P 500 rose 325 per cent (if you use year-end 2009 as the starting point). Earnings over the period grew 192 per cent. The rest of the gain was down to price/earnings ratios rising from 16 to 24. Much of the latter increase has been given back (the index is now on 18 times trailing earnings), even as earnings have hung in there, for now. How will household spending patterns respond to a shift in valuation without much shift in profits? One good readIf you’re reading this newsletter, decent chance you care about the Fed. Most people don’t, though. Could that matter to inflation expectations? More

The writer is president of Queens’ College, Cambridge, and an adviser to Allianz and GramercyFor the global economy and markets, last week marked a definitive “awakening”.As nice words from central banks about battling inflation gave way to more meaningful policy actions, there was a first awakening with the realisation that, undoubtedly, we were making a transition to a new and more challenging regime for financial conditions.And because this transition is so late in coming, there was a second awakening — a recognition that there is no hiding from the difficulties this poses for policymakers, households, companies and markets.Just look at what occurred last week. In the US, the Federal Reserve hiked its benchmark interest rates by 0.75 percentage points on Wednesday. That went not only against its own forward guidance of a 0.50 point rise but also contradicted something that chair Jay Powell had himself voluntarily dismissed a few weeks earlier, saying a 0.75 point increase was not being actively considered by the central bank.There is now no denying that, after a protracted period of resistance, the world’s most powerful central bank has loudly acknowledged that it has no choice but to address inflation more forcefully, regardless of the impact on markets.The following day in Europe, the Swiss National Bank raised rates by 0.50 points, surprisingly decoupling itself from the European Central Bank. That crystallised what many were starting to suspect. The SNB is a central bank long-accustomed to countering the appreciation of the franc. But after witnessing what has occurred in Japan and the UK, it joined the growing number of its peers wishing to pre-empt a currency depreciation that would make the inflation battle even harder to win.And all this happened in the week that the Fed started implementing the second element of policy tightening — that of reducing its $9tn balance sheet that has been bloated by the protracted programme of asset buying to support markets.It is undeniable that, after years of massive liquidity injections and floored policy rates, the world is in the grips of a generalised tightening of financial conditions that feeds on itself. This is not a cyclical phenomenon that will soon unleash mean-reverting forces.It is a secular regime change forced on reluctant central banks by inflation that has got well ahead of them and threatens livelihoods, worsens inequality and undermines financial stability.As it is late, this shift comes with a heightened risk of collateral damage and unintended consequences. That was evident last week as growth fears gripped markets with more forecasters jumping into the recession camp.The awakening is an important part of navigating through the risks facing the global economy. But the process cannot, and should not, stop here. There is more to be done if the intention is, as it should be, to limit the damage from the historical policy mistake initiated last year by the Fed when it stubbornly held on to its mischaracterisation of inflation as transitory.To continue to regain policy credibility, the Fed needs to follow the example of the ECB and explain why it got its inflation forecasts so wrong for so long, and how it has improved its forecasting capabilities.And to perform its intended and much-needed role of honest adviser, the Fed needs to follow the Bank of England in being frank and open about what’s ahead for the economy. As it persists in failing on both, it is no surprise that so many economists, including former Fed officials, were quick to complain last week that the central bank’s revised economic forecasts remained unrealistic.In 2016, I published The Only Game in Town*, which looked at what was already then excessive and protracted reliance on central bank intervention. I detailed why, within the next five years or so, the global economy and markets were likely to confront a “T junction” where an increasingly unsustainable path would give way to one of two contrasting roads.One was the path to high, inclusive and sustainable growth, and the other to recession, rising inequality and financial instability. The sooner policymakers recognised the dividing of the ways and acted accordingly, the greater the likelihood of the better road prevailing.Unfortunately, this was not done. As such, the global economy is now facing growth disruptions, harmful inflation, greater inequality, and unsettling financial market volatility. Having failed to act to prevent this unfortunate turn, policymakers must now step up more firmly to limit the overall damage and to better protect the most vulnerable segments of our society.*The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse More

The writer is chair of Rockefeller InternationalChina’s rise on the world stage is perhaps this century’s most frequently repeated news story. The country’s economic footprint has expanded spectacularly. Its widening military reach has made recent headlines. Yet as an aspiring financial superpower, China is going nowhere.This has not happened before. The US rose as an economic force and then as a financial power, before the dollar became the world’s leading currency in the 1920s. Previous empires, from Britain to 15th century Portugal, followed a similar arc, as investor Ray Dalio recently showed. China is breaking the mould, rising rapidly as an economic force but glacially as a financial power. In doing so, the country is defying expectations. Two decades ago, when China opened to global trade, it seemed on track for global economic and financial supremacy. Around 2010, Beijing began broadcasting its financial ambitions — which included establishing the renminbi as a global currency. Then came a burst of progress, followed by retreat. Since 2000, China’s share of global gross domestic product has almost quintupled from 4 per cent to 18 per cent and its share of global trade has quadrupled to 15 per cent. No other economy has grown faster. Yet its stock market has been among the world’s weakest performers. China’s rise has such a grip on the popular imagination that many analysts still see it everywhere. They depict the renminbi’s tiny 3 per cent share of global central bank reserves as quick progress because it is up from 1 per cent five years ago.But this share is similar to those of far smaller economies like Canada or Australia, and well behind what analysts have been projecting. The hurdle is trust: foreigners are wary of a meddling state, but more importantly, the Chinese distrust their own financial system. China has printed so much money to stimulate growth over the past decade, the money supply now dwarfs the economy and markets. That capital may flee when given the chance. When Beijing was facing significant outflows seven years ago, the government imposed controls to prevent capital flight. It has yet to lift them. Instead, China has turned financially inward. Since 2015, the renminbi share of payments through the Swift network for international bank transactions has fallen by a fifth, from an already negligible level under 3 per cent. A widely followed index that ranks 165 nations by capital account openness puts China at 106th, tied with tiny states like Madagascar and Moldova.While Chinese investors are restricted from investing abroad, foreigners are scared away from China by erratic government attempts to control the market. That helps explain why unlike in other nations, stocks in China do not rise and fall with economic growth.Economist Jonathan Anderson recently wrote that, considering its volatile prices and the vastness of its money supply relative to its markets, China is less comparable to emerging markets such as Brazil and Thailand than to frontier markets like Kazakhstan or Nigeria — and “should not be part of a standard EM portfolio.” Often it is not. Foreigners own about 5 per cent of stocks in China, versus 25 to 30 per cent in other emerging markets, and about 3 per cent of bonds in China, compared to around 20 per cent in other developing nations.Global doubt about China’s markets limits the renminbi’s appeal. Today, over half of all countries use the dollar as their anchor, a soft peg to manage their currencies. None use the renminbi. About 90 per cent of foreign exchange transactions involve the US dollar, while only 5 per cent use renminbi.This differs from the success stories China seeks to emulate. During its boom in the 1980s, Japan was rising both as a financial and economy power. The Japanese yen and stocks reflected that strength, and Tokyo emerged as a global financial centre. Today, the renminbi is not viewed as a safe haven, Chinese stocks languish and no Chinese city is more than a regional financial centre.China still aims to become a financial superpower. Its leaders understand that as a country gets richer, it has greater need for a functional financial system. The Chinese government has seen how the mighty dollar allowed the US to militarise finance in sanctioning Russia, and wants that same leverage.But for now, Beijing doesn’t have the confidence to take the basic steps of lifting capital controls and making the renminbi fully convertible. Until it does, China will never fully realise its superpower ambitions. More

Ethiopia’s prime minister Abiy Ahmed said this month that his government would negotiate with fighters in the northern Tigray region to end a war that has not only unleashed human rights abuses and killed thousands of people but has also derailed one of Africa’s most promising economies.Until civil war broke out in November 2020, Ethiopia — Africa’s second-most populous country with 114mn people — had been regarded by development economists as a success story, albeit one engineered by an authoritarian government. In the 15 years to 2019, driven by investment in agriculture, industry and infrastructure, the economy grew on average 7 per cent annually per capita, according to World Bank data, one of the fastest rates in the world. Although it was still relatively poor, with a nominal per capita gross domestic product of roughly $950 in 2020, years of growth had put it on the cusp of lower middle-income status.“There’s no doubt that Ethiopia made tremendous gains through the development-state approach,” said Kingsley Amoako, former executive-secretary of the UN Economic Commission for Africa, referring to the country’s Asian-inspired state-led model.Ethiopia’s unfinished economic miracle appeared all but dead as war caused what officials estimated to be “billions of dollars” in lost growth and destroyed roads, factories and airports. The conflict also shattered a fragile political truce through which, for nearly 30 years under the tight control of a coalition led by the Tigray People’s Liberation Front, the country’s main ethnic groups sought to set aside their differences in the interests of national development. A fighter loyal to the Tigray People’s Liberation Front © Ben Curtis/APThe economy received a further jolt when, after war broke out in 2020, foreign donors withdrew billions of dollars in financial support. Last year, Washington tightened sanctions further, ending Ethiopia’s tariff-free access to the US market and threatening thousands of jobs in a burgeoning textile industry. Now, though, the prospect of peace talks has raised hopes — however tentative — that Ethiopia’s economic momentum can be restored. “We’re just going to slow down, before we start coming up again,” said Tewodros Mekonnen, an Addis Ababa-based economist. If the conflict could be permanently resolved, he said, the economy could recover.A permanent ceasefire could unlock more than $4bn in frozen funding, according to officials, and ease a crippling shortage of foreign exchange that plagued the economy even before the war began. “Without peace, there is no economy,” said Abie Sano, president of the state-owned Commercial Bank of Ethiopia, the country’s largest lender.Still, given the intensity of the war and the impact of coronavirus, Ethiopia performed better than many expected. Last year, the mainly agricultural economy grew 6.3 per cent, according to the IMF, below the level of previous years but much higher than the continental average. Although some have questioned the reliability of that data, Stefan Dercon, a professor of economic policy at Oxford university and an expert on Ethiopia, said that GDP measured the flow of income and would not immediately register the impact of destroyed assets. Spending on the war itself could actually boost economic activity in the short term, he added. Farmers harvest crops of sorghum in a field near the village of Ayasu Gebriel © Eduardo Soteras/AFP/Getty Images“Despite appearances, the conflict remained relatively localised,” Dercon said. “So big parts of the country were as stable or unstable as they were in previous decades when you had fast growth.” Ahmed Shide, Ethiopia’s finance minister, told the Financial Times that the economy was grappling with “multiple challenges and shocks, both internal and external”. But, he said, it continued to benefit from strong fundamentals, the good performance of Ethiopian Airlines, Africa’s largest carrier, and the liberalisation of the telecoms sector. “The economy is resilient despite multiple shocks,” said Shide. Even so, this year will be harder. The IMF expects economic growth to slow to just 3.8 per cent, partly as a result of the war in Ukraine and a severe drought in parts of the country. Inflation is forecast to hit 35 per cent, stoked by local and global supply chain problems.For the economy to recover, Sano said it was essential for the government to press ahead with liberalisation. Before the war in Tigray, Ethiopia had started the process of selling off new telecom licences. Last year, it accepted an $850mn bid from a British-backed consortium led by Safaricom, a Kenyan operator. The government envisages a partial sell-off of state assets, including a second telecoms licence and a stake in Ethio Telecom, the state provider, as well as parts of logistics operations such as Ethiopian Shipping Lines. “We need capital and in order to have capital, we need reforms,” Sano said. Under the late Meles Zenawi, a former Tigrayan guerrilla fighter and national leader until his death in 2012, the state dominated the economy. “We had impressive growth, but when you dissect it was very clearly public-sector driven, which was not sustainable,” said Tewodros. “We have to balance some of our public investments by bringing in the private sector.”Although Ethiopia funded much of its spending through domestic savings, it also borrowed from foreign lenders, including China. Last year, Addis sought debt relief under a G20 framework to help countries battered by the Covid-19 pandemic.The government recently launched what it hopes to be a $150bn sovereign fund and is planning to open the country’s first stock market next year. “We want to build progressive capitalism that will harness the power of the market, as well as the sustainable role of the state,” Ahmed said.Violence in several regions continues and the constitutional questions that stoked the war in Tigray have not been resolved. It will be hard, analysts say, for Abiy to forge lasting peace with Tigray, which is still under partial blockade, or to persuade the TPLF to accept market reforms that will slowly unpick the state-led model it pioneered. “Abiy came for revenge not for reform,” said Kindeya Gebrehiwot, a former president of Mekelle University and a senior member of the TPLF. “Development needs serious thought, planning and bringing everyone on board,” he said. “All the initiatives he has taken are damaging national harmony.”

Mamo Mihretu, a top economic adviser to Abiy, said the government’s market reforms remained on track. “Successive shocks have not diminished our resolve to build an economic model that can resolve legacy challenges,” he said.Dercon at Oxford said it was too early to write off Ethiopia’s economy. “It’s not that the economic miracle is gone, but the economic model is gone,” he said, referring to state-led development. “Will it go back to growth of 7-10 per cent? I don’t know,” he said. “But to give up and say it won’t grow at all, I don’t think so.” More

The eurozone is well placed to ride out recent market volatility and its economy will grow this year and next, the eurogroup president said, denying that the currency union faces a crisis akin to that which struck a decade ago.Paschal Donohoe, who is Ireland’s finance minister as well as chief of the pan-eurozone group of finance ministers, said current circumstances were “completely different from the kind of crisis environment we were in” when the bloc was gripped by a spiralling sovereign debt sell-off in the early 2010s. Donohoe said the euro area now had “stronger architecture” and “deeper foundations for our common currency”. Since the region’s last debt crisis, the EU has bolstered its bank regulation with the creation of a pan-European supervisor and crisis-fighting infrastructure through a common resolution mechanism when lenders fail. The European Central Bank has new tools to buy government bonds, while lawmakers created a recovery fund backed by common debt during the coronavirus pandemic. “We are all confident about our ability to navigate through the changes that are taking place,” he said.Surging inflation and fraying confidence, stemming in part from energy supply disruptions caused by Russia’s full-scale invasion of Ukraine in February, have sparked fears that the eurozone is heading into a sharp downturn. As the ECB joins other policymakers in lifting interest rates, those fears have intensified. Italian and Spanish bond yields hit their highest levels for eight years last week as market jitters intensified.Donohoe’s remarks came as ECB president Christine Lagarde prepares to face questions from MEPs at the European parliament on Monday over its recent contrasting messages. Lagarde had sounded tough on inflation after the central bank’s governing council met in Amsterdam on June 9, when it decided to end eight years of negative interest rates and massive bond purchases. But last Wednesday, the ECB announced at an emergency meeting that it was speeding up work on a new “anti-fragmentation instrument” to prevent borrowing costs from surging disproportionately in weaker countries such as Italy. German finance minister Christian Lindner suggested last week that the ECB had overreacted to the sell-off in bond markets. Lindner claimed the euro area was “stable and robust” and there was “no need for any concern” about some countries’ borrowing costs rising faster than others. Although member states would have to commit themselves to credible plans for reducing public borrowing and managing inflationary pressures — the pace of price growth has topped 8 per cent — Donohoe insisted that a strong labour market pointed to economic expansion.Donohoe highlighted employment growth as well as support from the EU’s €800bn NextGenerationEU programme, which he said would sustain the region’s economic expansion even if growth expectations have been cut.Hiring, he added, was set to be a “very powerful source of momentum”, as was the implementation of post-Covid-19 recovery plans. The eurozone economy is set to grow 2.8 per cent this year and 2.1 per cent next year, according to forecasts this month from the ECB. But the central bank also said a downside scenario involving Russia cutting off all energy supplies to Europe would lead the bloc’s economy to shrink 1.7 per cent next year. The likelihood of such a scenario has risen after Moscow drastically reduced gas flows to Germany and Italy. European capitals are attempting to strike a delicate balance between helping inflation-struck households while reducing public debt. The eurogroup is shifting from recommending that member states take a mildly supportive fiscal stance to a neutral policy, with more targeted support.Governments’ borrowing soared during the pandemic as tax receipts fell sharply and spending on healthcare and economic measures ballooned.“The starting positions for member states in terms of their debt and deficit levels is now very, very different to where we were before Covid hit us,” said Donohoe. “We will continue to need to have plans that reduce borrowing in a careful way. The plans to do it will have to be credible. They will have to reflect the fact that we are in an inflationary environment.”Excessive levels of borrowing can themselves “contribute to the inflationary pressures we are currently trying to reduce”, the Irish finance minister added. “This is going to be a fine balance.” 

Some politicians have argued that the EU should undertake more joint borrowing to help support the energy transition and other priorities. But Donohoe insisted that member states wanted to focus on implementing existing plans. “The scale of what we have agreed is so big that it would need some time for us to be able to show that has been fully executed,” he said. Asked whether there needed to be economic conditions attached to any targeted bond-buying by the ECB, Donohoe declined to comment, saying the central bank would “do their work independently”. “We do accept there are changes in market conditions, which is understandable as monetary policy changes to reflect a changing economy,” he said. Yet there was “unity of purpose in ensuring that we have the plans and steps in place to maintain the resilience of the euro and the euro area”.Additional reporting by Martin Arnold in Frankfurt More

The one-year loan prime rate (LPR) was kept at 3.70%, and the five-year LPR was unchanged at 4.45%.About 90% of traders and analysts in a Reuters survey last week expected China to both rates unchanged, as global central bank tightening limits room for policy manoeuvre to arrest an economic slowdown.Most new and outstanding loans in China are based on the one-year LPR. The five-year rate influences the pricing of mortgages. More