Aurelia Butler

The economic crisis in Sri Lanka is deepening. The rupee has plunged to record lows against the dollar on the back of blackouts, food shortages and sky-high prices. The country may have as little as $500mn left in foreign reserves though a $1bn bond repayment is due in a few months. With the IMF ready to intervene, there is hope that the situation may stabilise. But fears are growing that Sri Lanka could be the first in a series of emerging markets to descend into economic turmoil.The war in Ukraine represents another shock which, on the back of the pandemic, could be enough to send multiple countries into debt distress. The scope of the problem is likely to be global, so solutions need to be of a similar size and scope. Unfortunately, garnering enough international political will to fix holes in the world’s framework for sovereign debt relief looks to be a Herculean task.Russia’s war in Ukraine leaves developing countries facing a twofold shock. Spiralling oil and grain prices have put importing economies under pressure, with countries such as Egypt facing the prospect of drastically lowering their foreign currency reserves in order to pay for them. On top of this comes the prospect of monetary tightening in the developed world.In 2013, the merest hint from the US Federal Reserve that it would scale back quantitative easing — the so-called taper tantrum — was enough to move money out of emerging markets. What happens in the event of a significant unwinding of the Fed’s balance sheet remains to be seen. The prospects, however, are not good: rates will rise, and some developing economies could find that their debt burdens become unsustainable.The path from there could be grim. Spending cuts are likely to be made in an effort to meet bond repayments as they become due. This kind of fiscal retrenchment tends to exacerbate poverty, cut off growth paths and cause unpredictable social upheaval.This course of events is not inevitable, though. To start with, the IMF should dust-off its pandemic playbook and offer rapid loans to vulnerable economies. This could be accompanied by less stringent conditions to match the urgency of the situation, ensuring that countries spend what is required to meet the challenges of the moment.In the medium term, gaps in the world’s approach to sovereign debt relief must be fixed. It is no longer sufficient to concentrate on the old Paris and London clubs of lenders — long gone are the days of emerging market creditors being concentrated in this group. China now represents the biggest bilateral lender to developing countries by far and bonds have also been sold to a range of private investors. According to the World Bank, at the end of 2020, low and middle income countries owed five times as much to commercial creditors as they did to bilateral ones.These lenders will need to co-operate if there is to be any hope of significant, proactive debt relief to emerging markets. The common framework agreed by the G20 in November 2020 offers a potential vehicle, but the will to make use of it is lacking. Creditors still fear that their agreement to offer concessions will just become a covert means of redistribution to other lenders unwilling to play ball.At a time of increasing division, and with priorities lying elsewhere, hope for rectifying these issues with the world’s sovereign debt framework may fade. It would be a great shame if this were so. Economic turmoil in emerging markets does not need to result in serious crises. It is clear what needs to be done. The task now is to find the necessary political will to do it. More

Right now, the dollar is the world’s most popular reserve currency by some margin. It plays a vital role in facilitating world trade and global finance, enabling the US to use it as a mightily effective weapon against those who stand against the aims of its foreign policy. Yet some think the weaponisation of the dollar against Russia will hasten the dollar’s demise. Countries at odds with Washington will start switching their war chests of reserves into other currencies, they argue. Add this to the long-term trend of America’s declining share of global output and trade and the dollar’s future would seem dark. Yet, shifting the composition of your reserves is easier said than done. While the dollar’s appeal has waned, the switch to other currencies has only been slight — as the IMF’s latest Cofer figures show: History offers some clues on how things might shake out. As a note published by Goldman Sachs’ Cristina Tessari and Zach Pandl last week points out, a nation’s reserve currency status often lingers longer than other facets of its global dominance. The Goldman note looks to the example of the UK, from whom the US inherited its reserve currency crown. Here’s the back-story: There were two major reasons for the predominance of the pound as an international currency in the latter part of the 19th century. First, there was the overwhelming predominance of the United Kingdom in world trade. The UK absorbed more than 30% of the exports of the rest of the world in 1860 and 20% in 1890. Moreover, between 1860 and 1914 probably about 60% of world trade was invoiced and settled in sterling. Although the UK ran a deficit on merchandise trade before first world war, net income from shipping, insurance, interest, and dividends were more than sufficient to produce a substantial current account surplus. Intimately connected with these trading activities, there was also a large export of British capital to the rest of the world. A continuous net export of capital between 1848 and 1913 brought up UK’s total net external assets to the amount of nearly £4,000 million by 1913, which represented 166% of nominal GDP. Sterling was not only used when invoicing, financing, and settling trade-related transactions, but also as a buffer against future needs, ie, as a reserve. In 1899 the share of pound in known foreign exchange holdings of official institutions was more than twice the total of the next nearest competitors, the franc and the mark, and much greater than the dollar.Sounds familiar to the dollar’s role in global finance today right? So what comes next? Well a drop in the UK’s economic influence did not immediately lead people to ditch sterling. While Britain’s share of world trade began to decline during the 1920s, the pound remained the reserve currency of choice up until the second half of the 1950s, when it was finally overtaken by the dollar.

Goldman Sachs argues that the dollar today faces many of the same challenges as the pound in the early 20th century. Those include a small share of global trade volumes relative to the currency’s dominance, a deteriorating net foreign asset position, and adverse geopolitical trends. At the same time, there are important differences — among them less severe domestic economic conditions than those the UK faced in the 1950s. Which leads to this conclusion: If foreign investors were to become more reluctant to hold US liabilities — Eg because of structural changes in world commodity trade — the result could be dollar depreciation and/or higher real interest rates in order to prevent or slow dollar depreciation. Alternatively, US policymakers could take other steps to stabilise net foreign liabilities, including tightening fiscal policy. The bottom line is that whether the dollar retains its dominant reserve currency status depends, first and foremost, on US’s own policies. Policies that allow unsustainable current account deficits to persist, lead to the accumulation of large external debts, and/or result in high US inflation, could contribute to substitution into other reserve currencies. Interesting indeed. However, we think there are other important differences between then and now that the note neglects to mention. Chiefly the question of dollar substitutes. Right now the biggest threat to Washington’s dominance, both militarily and economically, is Beijing. Yet there remain a dearth of yuan-denominated assets that investors can purchase. This isn’t necessarily about China needing to turn its current account surplus into deficit and create the equivalent of the US Treasury market. As the Goldman note rightly points out, the UK often ran current account surpluses during the period when the pound was the most popular global currency.

Yet it will need to open up access to its capital markets far more than it has done so far. For all the talk of ending the dollar’s hegemony, Beijing is only letting the renminbi become more convertible on its own terms. Which happen to be rather slower than international investors would like. Secondly, money is as much a legal construct as an economic one. The dollar’s dominance works because people largely trust things like New York law, and institutions like the Federal Reserve (no sniggering at the back please). And there is relatively little difference between them and the legal framework of England and Wales (and the workings of the Bank of England). Certainly when one sets them against the decision-making process in Beijing. However, that does not mean that the dollar’s dominance is entirely unassailable. We imagine most people reading this would rather have the US as the world’s financial policeman than China. But the reality is that many in positions of power in places like India, or Brazil, may not share that view. The greenback’s reserve status reflects many things — including how willing other countries are to align themselves with US foreign policy. And how powerful those countries that do share Washington’s views are on the global stage. Which leads us to conclude that rather than trying to work out whether the dollar will be toppled, a more probable course may be a move to a multipolar world of two economic systems. One where the greenback remains top dog, another where it is supplanted by the renminbi. More

The rouble’s recovery has been wrongly used as evidence of Russia shrugging off the west’s sanctions. But there are signs that the country’s financial sector is finding its feet after the initial barrage from the sanctions.The Institute of International Finance’s economists Elina Ribakova and Benjamin Hilgenstock rightly point out that the rouble’s bounce should not really surprise anyone. Imports have been crushed, interest rates have been doubled, harsh capital controls have been put in place, and Russia’s oil and gas sales means it continues to accumulate foreign earnings. Those revenues are absolutely monstrous. The IIF estimates that Russia made more than $1b a day in March, which — absent further action on oil and gas sales — will help make up for chunks of its central bank reserves being frozen by the west:While the CBR’s reserve operations have been limited due to sanctions, historically-high current account surpluses —$39bn in January-February, likely an additional $30-40bn in March, and possibly above $250bn for the full year (absent an energy embargo) — Russia should be able to regain “lost” reserves in a relatively short period of time. The domestic banking sector also seems to have stabilised, after bank runs in the initial days of the war. The need for central bank liquidity has faded sharply and the commercial banking sector as a whole could soon end up having surplus deposits with the CBR, the IIF notes.

The IIF therefore concludes that if the west wants to maintain the pressure on Russia, let alone ramp it up, then sanctions will have to be continually calibrated and expanded, such as by cutting more Russian banks off from Swift. The next big step, however, would be an embargo on oil and gas exports, which the IIF seems to think might be coming. FT Alphaville’s emphasis below:Western sanctions have largely focused on the financial sector so far, even if some sanctions have de facto become trade sanctions, partially due to self-sanctioning by international companies. However, as Russia’s economy and financial sector adapt to a new equilibrium of capital controls, managed prices, and economic autarky, it is not surprising that some of the domestic markets stabilise. Furthermore, due to the policy response and likely large current account surplus, sanctions have become a moving target and will require adjustments over time to remain effective. We believe that the likely next steps will be a further tightening of financial sector sanctions, potentially the disconnecting of additional Russian institutions from SWIFT. Finally, while resistance to an energy embargo remains substantial in many European countries, including but not limited to Germany, it is increasingly unlikely that this position can be upheld for much longer should more evidence of Russian war crimes emerge. More

This is the second part of a series on the weaponisation of financeTwo weeks after Russian tanks rolled into Ukraine, South African president Cyril Ramaphosa held a phone call with Russia’s Vladimir Putin. On the same day, European leaders meeting in Versailles warned democracy itself was at stake. Yet Ramaphosa struck a very different tone.“Thanking His Excellency President Vladimir Putin for taking my call today, so I could gain an understanding of the situation that was unfolding between Russia and Ukraine,” he wrote on Twitter. Ramaphosa, who has blamed Nato expansion for the war, said Putin “appreciated our balanced approach”.The South African president is not alone in pursuing a “balanced” position to the war. “We will not take sides. We will continue being neutral and help with whatever is possible,” Brazil’s Jair Bolsonaro said after Russia invaded Ukraine. Mexican president Andrés Manuel López Obrador also declined to join the sanctions being imposed on Russia. “We are not going to take any sort of economic reprisal because we want to have good relations with all the governments in the world,” he said.And, then, there is China: an increasingly close ally of Russia. The world’s second-largest economy has scrupulously declined to criticise the invasion of Ukraine. It might seem that most of the world is united in condemnation of the war in Ukraine, but while there is a western-led coalition against Russia, there is no global coalition. This could have important implications for the future of international finance as countries around the world respond to the dramatic move by the US and its allies to freeze Russia’s foreign currency reserves.“The sanctions have been earth-shattering,” admits John Smith, who used to be the leading sanctions official at the US Treasury department and now co-heads the national security practice at Morrison & Foerster, a law firm. “They’ve broken the mould.”The power of the sanctions on Russia is based on the dominance of the US dollar, which is the most widely-used currency in trade, financial transactions and central bank reserves. Yet by explicitly weaponising the dollar in this way, the US and its allies risk provoking a backlash that could undermine the US currency and sunder the global financial system into rival blocks that could leave everyone worse off.“Wars also upend the dominance of currencies and serve as a doula to the birth of new monetary systems,” says Zoltan Pozsar, an analyst at Credit Suisse.China, in particular, has long-term plans for its currency to play a much bigger role in the international financial system. Beijing views the dollar’s dominant position as one of the bulwarks of American power that it wants to chip away at, the flipside of the US Navy’s control of the oceans. The Ukrainian conflict will solidify this view.Zhang Yanling, former executive vice-president of Bank of China, said in a speech last week the sanctions would “cause the US to lose its credibility and undermine the dollar’s hegemony in the long run”. She suggested China should help the world “get rid of the dollar hegemony sooner rather than later”.The death of the dollar has been predicted on countless occasions before, only for the US currency to maintain its position. Inertia is a powerful force in cross-border finance: once a currency is widely used, that becomes a self-perpetuating position.But if there is a steady shift away from the dollar in the coming years, the sanctions on Russia’s central bank might come to be seen not as a bold, new way of exerting pressure on an opponent but the moment when the dollar’s dominance began to decline — a financial Suez Canal.Analysts point out that previous examples of financial warfare have mostly related to blocking money for terrorism or deployed in specific cases such as Iran’s nuclear programme. Targeting a country of Russia’s size and power is unprecedented, and for better or worse it could become a blueprint for the future, argues Mitu Gulati, a financial law professor at the university of Virginia. “If you change the rules for Russia, you’re changing the rules for the whole world,” he says. “Once these rules change, they change international finance forever.” ‘It was simply theft’As Russia accelerated its build up of forces on the border of Ukraine earlier this year and the threat of war hung in the air, the country’s leading financial officials conducted a stress-test of the impact of potential sanctions.But when one senior Russian banker suggested modelling what would happen if the rouble went over the symbolic mark of 100 to the dollar — a huge jump at the time — the suggestion was dismissed as unrealistic.By the end of February, Russia had launched an invasion of Ukraine, sanctions had been introduced and a large part of the Russian central bank’s foreign reserves had been frozen. Western governments surprised themselves and Moscow with the strength of their economic response to the war. As a result, the rouble fell to 135 against the dollar, a depreciation of about 50 per cent since the start of the year.“No one who was forecasting what sanctions the west might impose could have predicted that, when the central bank reserves [were frozen],” Russia’s foreign minister Sergei Lavrov said in March. “It was simply theft.”Five weeks into the war, the situation looks different — at least superficially. The rouble has regained most of the ground it lost in the days after the sanctions were first announced — prompting some Russian officials to claim that the measures had failed.“This is the beginning of the end of the dollar’s monopoly in the world,” Vyacheslav Volodin, speaker of the Russian Duma lower house of parliament, said on Wednesday. “Anyone who keeps money in dollars today can no longer be sure that the US will not steal their money.”Volodin added: “The ‘hellish’ sanctions didn’t work. They hoped to collapse the economy and paralyse Russia’s banking system. It didn’t work.”But analysts say the rebound largely reflects the draconian capital controls and interest rate increases Russia has unveiled in response. They add that the economic impact is undoubtedly going to be severe, regardless of the rouble’s movements. “It’s very grim,” says Carmen Reinhart, the World Bank’s chief economist. “Modelling at a time like this is an art, so I don’t want to be too precise, but we’re talking about significant, double-digit declines in economic activity and skyrocketing inflation.”Nonetheless, there are a few tentative signs that Russia could find ways around the sanctions that bypass the dollar-based US financial system. One area is trade. India, a country which is eager to maintain the independence of its foreign policy, has been flirting with the idea of providing a payments backdoor to Russia.Indian officials say the government and central bank have looked into the viability of a rupee-rouble arrangement — a mechanism the two countries used during the Soviet Union era, which also involved barter trades involving oil and other goods. But officials stress that the issue is not yet settled. Such arrangements are “not easy to undo once the crisis goes,” one official cautions.Some fear the war is the beginning of a profound shift in the global economy. Larry Fink, the chief executive of BlackRock, the world’s largest investment group with $10tn of assets under management, argued in his annual letter to shareholders that “the Russian invasion of Ukraine has put an end to the globalisation we have experienced over the last three decades”. One result, he said, could be a greater use of digital currencies — an area where the Chinese authorities have made significant preparations. Even the IMF believes the dollar’s dominance could be diluted due to the “fragmentation” of the system, although it will likely remain the primary global currency. “We are already seeing that with some countries renegotiating the currency in which they get paid for trade,” says Gita Gopinath, the IMF’s first deputy managing director.The sanctions could also accelerate changes in the infrastructure of international finance. As part of its push to reduce dependence on US-controlled systems, China has spent years developing its own renminbi-denominated cross-border interbank payments system (Cips), which now has 1,200 member institutions across 100 countries.Cips is still small compared with Swift, the European-based payments system, which is an important part of the sanctions regime against Russia. But the fact that the biggest Russian banks have been kicked off Swift has given a potential growth opportunity to the Chinese rival.

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“Cips has the potential to be a game changer,” says Eswar Prasad, a former senior IMF official now at the Brookings Institution. “China is setting up an infrastructure for payments and payment messaging that could one day provide an alternative to the western-dominated international financial system and in particular Swift.”Even before the war, there were also tentative signs of a big shift already under way in the composition of central bank reserves — one of the main building blocks of the international financial system. US government debt has for much of the past century been central banks’ preferred place to stash away rainy-day money, given the size and strength of the US, the safety and tradeability of its debt and the dominant role of the dollar in international trade and finance. In the 1960s, former French president Valéry Giscard d’Estaing called this America’s “exorbitant privilege”. But that privilege has been eroded in recent decades. Of the $12tn worth of foreign currency reserves held by central banks around the world at the end of 2021, the dollar accounts for about 59 per cent, according to the latest IMF data. That is down from 71 per cent in 1999, when the euro was launched. The European common currency is the principal dollar alternative — it accounts for 20 per cent of central bank reserves — but there has also been a marked shift into smaller currencies such as the Australian dollar, the Korean won and above all the Chinese renminbi, according to Barry Eichengreen, Berkeley economics professor who is the dean of studies of the international monetary system. In a recent report co-authored with the IMF, he called this “the stealth erosion of dollar dominance”, and argued it “hints of how the international system may evolve going forward”. The use of central bank sanctions would probably accelerate the process, he told the Financial Times. “It’s a huge deal. Freezing the assets of the Russian central bank certainly came as a surprise to me, and it would appear to Putin as well,” he says. “These issues have always come up in the past whenever the words ‘weaponise’ and ‘dollar’ are spoken. The worry is always that this will work to the disfavour of US banks, and you go some way towards eroding the dollar’s exorbitant privilege.”Yu Yongding, a leading economist at the Chinese Academy of Social Sciences, said in a speech last week that sanctions had “fundamentally undermined national credibility in the international monetary system”. Yu, who used to be an adviser to the Chinese central bank, added: “What contracts and agreements can’t be dishonoured in international financial activities if foreign central banks’ assets can be frozen.”Is it too early for the death knell of the US dollar?Yet for all the speculation about the impact of the sanctions, there are also strong reasons to believe they will not promote a shift in the tectonic plates that underpin global finance — at least for the foreseeable future.Despite the recent rebound in the rouble, there is no easy way for Russia to escape from the impact of the sanctions. Natalya Zubarevich, director of the regional programme of the Independent Institute for Social Policy, says people are expecting results “too quickly” from the sanctions. “Sanctions do not work quickly,” she says. “The other sanctions will have an effect over months, not days.” Moreover, the threat of US and European sanctions on entities that actively try to help Russia evade the financial blockade will be a major deterrent — even for banks in countries that are amenable to helping Moscow. Nor is it easy for challengers to displace the dollar. The uncomfortable realisation for countries that might now be nervously eyeing their vulnerability to similar sanctions is that there is simply a lack of viable alternatives. Even Eichengreen says he is nowadays less worried about the dollar’s standing than he used to be, after it survived the “erratic” presidency of Donald Trump.That dilemma is particularly acute for China. With foreign currency reserves of $3.2tn that need to be invested, it has no choice but to have extensive dollar holdings. Outside of Europe and potentially Japan, which have stood shoulder-to-shoulder with America in this case, there simply are not enough liquid financial assets in other currencies to meet that demand.“We have very accommodative monetary policy, we are very open with our markets, things are easily convertible and we are safe as an economy. Until those things change, the rest of it ain’t changing,” says Brian O’Toole, a sanctions expert at the Atlantic Council and former senior official at the US Treasury. “If we’re acting with all of our partners and allies in this, where else are you going to go? There’s no place else that has anything approaching the level of liquidity and access that the US market has. It doesn’t exist anywhere.”China also faces an intractable problem if it wants other countries to hold its currency in their reserves. Its capital controls are not as strict as they used to be, but the renminbi is still not a fully convertible currency. In the decade since it first started trying to internationalise the renminbi, the Chinese Communist party has come to realise it can have a global currency that might one day rival the dollar or it can retain tight control over its domestic financial system, but it cannot have both.Prasad points out that despite the message that countries can no longer rely completely on “their carefully built up war chests at times of war” in light of the “quite dramatic moves by the western economies”, there is simply a paucity of viable alternatives. “The harsh reality though is that the renminbi at this stage is not a big enough player in international finance to be a viable alternative to the dollar,” he says.Paramilitary police officers march at the Bund, in front of the Lujiazui financial district of Pudong in Shanghai. The Chinese Communist party has come to realise it can have a global currency that rivals the dollar or it can retain tight control over its financial system, but it cannot have both © Aly Song/ReutersGiven the profound changes that have taken place in the global economy over the last four decades, it might seem an anachronism that the traditional western allies still dominate the financial world. But for the time being, there is little escape from the hold that their currencies enjoy.Smith, the former Treasury official, points out that “the death knell of the US dollar in the international economy has been sounded every year” since roughly 2008, when Washington first blocked Iran from using the US dollar for its international energy transactions. But nothing tangible has ever come from it. “There’s been a lot of hoopla ever since about the US dollar losing its status as the reserve currency and the currency of choice in the energy markets and in the international economy, [but] we have not seen that occur,” he says. “The US dollar has continued to remain strong as a source of stability in international financial transactions, and that is likely to continue even after the dust settles on the Ukraine war that Russia has unleashed.”Additional reporting by Sun Yu in Beijing and Chloe Cornish in Mumbai More

Owners of aircraft had a tough period during the pandemic but ship owners have been steaming ahead — and for investors eyeing this sector, there appears to be still more upside on the horizon. Key measures of shipping activity such as the Baltic Exchange Dry index shot up in the pandemic recovery, peaking at levels not seen since the early 2000s. That index has now fallen back but remains at elevated levels. A flotilla of publicly listed shipping businesses, ranging from funds through to the likes of Clarkson, a ship broker, have seen their share prices rocket. The listed funds segment of the London market has been a particular favourite as income-focused investors have backed two ship-owning, asset-backed funds: Tufton Oceanic Assets, which floated in 2018, and Taylor Maritime Investments, which listed last year. I have holdings in both.These closed-end investment companies have experienced rapid share price appreciation. This has pushed their once generous dividend yields of 7 per cent down to slightly less adventurous levels of 4.9 and 5.9 per cent respectively. Cynics might presume that the best is behind these funds as shipping markets stabilise — and possibly even cool off, should we see an energy induced recession — but I think they might still reward the patient investor.It is important to understand the characteristics of the two funds. Both started off as income-focused vehicles but benefited from a substantial uplift in net asset value as their ships appreciated in value. This meant both have been busy raising extra capital in recent months. They have been canny about buying the right kind of second-hand ship — the average fleet age of Taylor Maritime’s fleet is 11 years — and then trading ships as purchase prices have shot up. Tufton recently divested the container ship Vicuna for $18mn, realising a net internal rate of return of 46 per cent in a matter of a few years.Both have avoided the pitfalls of previous listed, asset-backed income vehicles — aircraft leasing funds, for instance — which used complex financial engineering involving lashings of debt and a layer of equity on top. Both also have a large fleet of ships — Tufton with 19 last time I counted, Taylor Maritime 30 — which aren’t as state of the art as the aircraft leasing funds’ massive, gleaming A380s. The funds have also avoided the dependence on just one big lessor and have fairly short charter durations ranging between a few months and a few years. But there are crucial differences between them. Tufton has a more diversified portfolio of ships including an early emphasis on container ships, as well as chemical tankers and bulk carriers in the smaller category known as Handysize. Taylor Maritime is heavily focused on Handysize bulk carriers and has also invested a fair amount of capital in a separate entity called Grindrod Shipping, an international shipping company listed in the US and South Africa, which owns a modern fleet of 25 predominantly Japanese-built geared dry bulk vessels.Again, some readers might well acknowledge these subtleties but pose a more basic question. Aren’t we past the best of the cycle and now into a more difficult spell? There’s no doubt the pace of activity has cooled. But Edward Buttery, chief executive of Taylor Maritime, points to substantial upside in the data on his Handysize bulker segment. This shows that congestion at ports is still at heightened levels, with not enough ships to go around. His prediction is that the current strong market will persist through to at least “2023 and beyond”.That rosy forecast does not, of course, cover another risk: a sudden flood of new ships being ordered and chartered out. Buttery’s response is that the bulker ship segment has not been prey to the overcapacity binges typical of the container ships sector. Looking at new ship orders he observes that “the Handysize order book remains the tightest of all dry bulk sectors. It is worth noting that the lack of capacity in shipyards is such that even if ship owners wanted to, they could not order more than a handful of ships before 2024.”

Another risk is the duration of charter periods. Taylor seems to have shorter duration contracts, largely because that’s where the market is currently paying the highest rates. Tufton appears to have slightly longer durations, with the average expected charter length running at 1.9 years. If demand were suddenly to freeze up, Taylor might be more vulnerable.Another risk is that older bulk and tanker ships operated by Tufton and Taylor Maritime suddenly become uneconomic because of tougher environmental regulations. Both funds are investing heavily in upgrading their ships — for instance, to use biofuels — but there’s no obvious answer to the rapid need to decarbonise the fleets. Most progress is likely to be around progressively replacing fossil fuels with alternative low or no-carbon fuel, such as methanol and ammonia. In the meantime, the owners of newer vessels with better fuel efficiencies are likely to be the beneficiaries — and both funds score highly on this measure.I remain optimistic. Both funds are churning out cash because of high returns on assets deployed. Tufton currently boasts a run rate yield on its fleet of 14 per cent. And there may be more upside to come on the value of those ships. The funds team at investment bank Jefferies have been running their slide rule over the two fleets and reckon both might be worth substantially more than is stated. Using data from Clarksons, they reckon that average second-hand price of a 10-year-old Handysize vessel has increased from $17mn at the end of 2021 to $18.5mn currently, which could imply a $35mn uplift in net asset value (NAV) for Taylor. This gives an estimated NAV of $1.73 a share, implying the shares trade at an 18 per cent discount. As for Tufton, the analysts have tentatively added another $20mn NAV uplift on their more mixed fleet, implying a NAV of $1.44 a share, which in turn equates to a 5.8 per cent discount. Jefferies also notes that the big Japanese shipyards are sharply pushing up prices on new ships to pay for extra energy and steel costs, thus supporting the price of existing ships.The rather mundane segments of the shipping market targeted by both funds have had bad decades in the past. There was a decade-long downturn in bulker rates before the current boom. And all the talk of strong asset backing could be pie in the sky if there is a sudden economic slowdown. But on balance I think there remains real potential for an uplift in values. And don’t forget those well-covered dividend payouts, which should satisfy the income-hungry investor.David Stevenson is an active private investor and has interests in securities where mentioned. Email: [email protected]. Twitter: @advinvestor More

The relationship between China and the US will shape the world’s future on every dimension. Alas, those relations have been deteriorating for a long time. Indeed, probably the only issue on which Republicans and Democrats agree is that China is a huge threat to America’s interests and values. Aaron Friedberg of Princeton University agrees enthusiastically with this view. Indeed, his major complaint is against those who ever believed anything different. Fred Bergsten agrees that this is now an enormously challenging relationship — yet takes a contrasting perspective on the threat.Bergsten is a doyen of American thinkers on international economic policy. The founder of the Peterson Institute for International Economics has devoted his life to the promotion of the liberal international economic order. His book, The United States vs China, starts from the view that preservation of that order should be our core objective. It also focuses on the economic aspects of the bilateral relationship, arguing that “It would be far superior, from both a US and global perspective, to decouple the economic issues from the inherently contentious security and values issues.”

Friedberg considers this hopelessly naive. For him economics cannot be separated from politics. The Chinese Communist party is, he argues in Getting China Wrong, a Leninist organisation ruthlessly dedicated to its own power. Quite simply, “Beijing believes that rivalry with the West is inescapable and the stakes are existential.” Bergsten’s analysis is made in terms of the “Thucydides trap” and the “Kindleberger trap”. The first concept comes from Harvard’s Graham Allison, who started from a pattern first identified by the great historian of the Peloponnesian war, in which a rising power (Athens) clashes with an established one (Sparta). The second concept came from the late Charles Kindleberger, who argued that interwar economic disaster was largely due to Britain being too weak to act as the hegemon the world economy then needed, while the US was too inward-looking to do so. In their economic relations, argues Bergsten, the US and China might now fall into the Thucydides trap. In so doing, they would also open the Kindleberger trap. The relationship between the US and China is fundamentally different from that in the cold war, which was an ideological and security conflict. The two sides were engaged in an economic competition, which the Soviets lost, but they were economically disengaged from each other. China, however, has created an economy that already matches America’s on many dimensions. Moreover, China and the west are economically interconnected with each other and the rest of the world.Bergsten concludes from these realities that the US must “reject any efforts to contain China. Even if it were desirable, containment cannot succeed, as President Trump demonstrated. China is too large and too dynamic to be suppressed and few, if any, other countries would join the United States in an effort to do so.”Fortunately, this will be unnecessary, since China is a “revisionist rather than a revolutionary power”. Bergsten’s core recommendation is what he calls “conditional competitive co-operation”.

Competition “will characterize much of their daily interaction through trade, investment, and financial exchanges”. But co-operation is essential to “provide a foundation for a stable and successful international economic order”. Conditionality will also be necessary, since both sides “will rightly insist that the other accept and faithfully implement agreed rules of the game to govern their interactions”.This leads to 10 policy recommendations. Among these are that the US should resume a global leadership role, everybody should continue to defend the current system and prevent its erosion, there should be a new multilateral trade package, and China should over time even be granted full quota and voting parity with the US in the IMF. The most important recommendation, concludes Bergsten, is for the US to undertake “a comprehensive program of domestic economic and social reforms to restore a sustainable political foundation for the country to exercise responsible global economic leadership again”.Friedberg’s analysis and recommendations are essentially the opposite. “What is emerging today,” he asserts, “is an intense, global, economic, technological, military, diplomatic, and ideological rivalry between two superpowers.” Whether we call it a “new Cold War” or use words like “containment” is neither here nor there. “Engagement was a gamble rather than a blunder,” he argues, “but the odds were always extremely long.” A “more accurate appreciation” of the CCP regime might have instilled “a greater sense of realism about the chances for success and a heightened sensitivity to early indications of failure.”

So what is to be done? Friedberg recommends four main lines of effort: “the United States and its partners must mobilize their societies for a protracted rivalry with China and harden them against CCP influence operations; partially disengage their economies from China’s while strengthening ties among themselves; intensify military preparations and diplomatic measures to deter coercion or aggression; and actively challenge Beijing’s ideological narratives, both in the developing world and, to the extent possible, inside China itself.”The two books differ on almost everything. Yet they do agree on two points: first, alliances with other liberal democracies are an immense asset for the US, especially in the economic struggle; second, Donald Trump was a catastrophe, not least because of his inability to recognise this reality. The books’ pre-eminent value is that they set out their opposing views with great clarity. Bergsten focuses on the huge potential gains from bringing China into the system as an equal partner. Friedberg sees an increasingly repressive, deceitful and irreconcilable enemy. Other perspectives exist. One is that the US, not China, is the more aggressive power. America has fought a series of foreign wars in recent decades, not China. It insists on strategic supremacy, not China. The US has 800 military bases abroad; China has just one. Moreover, under Donald Trump the US broke many of its international commitments, notably those in the World Trade Organization. The US may view its actions against China as purely defensive. Unsurprisingly China (and others) view them differently.Again, Friedberg is a moralist. He insists that the CCP, not China, is the enemy. But international realists would argue that ideology does not matter as much as China’s actual and potential power: friction is inevitable.I find Bergsten’s aspirations appealing and Friedberg’s view depressingly one-sided. But the latter’s perspective seems destined to win. This is partly because the push towards economic separation is now being driven by deep distrust on both sides. As important is the increased repressiveness of the Chinese regime and the re-emergence of one-man rule. Above all, China’s support for Russia’s invasion of Ukraine and attempt to split Europe from the US are unacceptable. China has, alas, chosen to be the west’s enemy. Whether Friedberg’s world was inevitable I do not know. It will be hard to escape from it now. This will prove to be a tragedy for humanity.The United States vs. China: The Quest for Global Economic Leadership by C Fred Bergsten, Polity £25, 384 pages Getting China Wrong by Aaron Friedberg, Polity £25, 246 pagesJoin our online book group on Facebook at FT Books Café More

After months of debate, the US Federal Reserve has a plan to shrink its $9tn balance sheet as it tries to tighten monetary policy and tackle the highest inflation in decades. Details of the plan were contained in minutes from the latest policy meeting in March, when the Federal Open Market Committee implemented the first interest rate increase since 2018 and signalled its intention to continue raising it to a “neutral” level that neither fuels nor slows growth. Besides interest rate rises, shrinking the balance sheet is the second pillar of the Fed’s plan to scale back the huge injection of monetary stimulus pumped into the economy at the onset of the pandemic. “It’s hard to look at the balance sheet plan the FOMC released and get the impression that they are anything but serious about removing policy accommodation,” said Robert Rosener, senior US economist at Morgan Stanley.Here is what the Fed has proposed and why financial markets are on edge:How will the Fed shrink the balance sheet?Officials broadly agree the Fed should shed up to $95bn of assets a month from the central bank’s huge balance sheet, and build up to that level over roughly three months starting in May. The Fed will seek to “roll off” $60bn of Treasuries each month by not reinvesting the proceeds from maturing bonds. When the amount of maturing Treasuries falls short of that level, the central bank has suggested making up the difference by reducing its holdings of shorter-dated Treasury bills, of which it holds roughly $325bn worth. The Fed also wants to reduce its holdings of agency mortgage-backed securities (MBS), which it started buying during the pandemic, capping the reduction in this asset class by $35bn a month. However, economists say it may fall short of this target given when the securities are expected to mature. Stephen Stanley, an economist at Amherst Pierpont, estimates holdings of agency MBS will decline by just $25bn a month. Fed policymakers have said they would consider selling some of the stockpile outright, rather than waiting for the securities to roll off the balance sheet, but this would only happen when the pruning process is “well under way”. How aggressive is the Fed’s plan?Surging inflation coupled with one of the tightest labour markets in history has prompted the Fed to plan a balance sheet reduction that would be much quicker than the last time it attempted to reduce its holdings. After hoovering up bonds in the wake of the 2008 financial crisis, the Fed waited until 2015 to raise rates and then a further two years or so before paring down its balance sheet. It then took about another year for the Fed to lift the cap on asset reduction to $50bn a month. Lael Brainard, a Fed governor who is poised to become vice-chair, said this week that a more rapid pace was warranted this time round “given that the recovery has been considerably stronger and faster than in the previous cycle”.The Fed has adopted a similar approach to raising interest rates, with many officials now backing half-point interest rate rises at one or more meetings this year — the first time such an increase will have been used since 2000. Wall Street is braced for multiple half-point adjustments, with the first coming in May.“By gradually dialling up the rhetoric, [the Fed has] allowed markets to recalibrate to this new monetary regime without an excessive tightening of financial conditions,” said Diana Amoa, chief investment officer of Kirkoswald, a hedge fund. How have financial markets reacted? The beginning of the end of the Fed’s pandemic-era stimulus has affected every corner of financial markets. The record rally in US stocks and the boom in the housing market were built on low borrowing costs ushered in by the Fed’s ultra-loose monetary policy. Borrowing costs have jumped since early March as the market anticipated higher interest rates, sending mortgage rates soaring and stocks plummeting from all-time highs. A smaller Fed balance sheet could accelerate those trends. As the Fed retreats, the supply of Treasuries available to investors will balloon, driving US government bond yields — which rose to three-year highs on Wednesday — higher still. Will there be liquidity issues? The flood of supply could also have an impact on liquidity — the ease with which traders can buy or sell — in the Treasury market, which has deteriorated to the worst level since the start of the pandemic.“This is a lot of Treasury collateral for the market to absorb in an environment where there is elevated volatility and a lot of uncertainty,” said Mark Cabana, head of US rates strategy at Bank of America.Chaos ensued the last time the Fed attempted to reduce its balance sheet. In 2019, short-term funding rates spiked, suggesting the central bank had withdrawn too much from the market. However, the Fed hopes it can avoid a rerun of that specific liquidity problem after it established a permanent facility last year that allows eligible investors to swap Treasuries for cash. 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European banks are stepping up their complaints to Brussels about a lack of clarity on how to implement EU sanctions on Russia and a “misalignment” with equivalent measures imposed by the US and UK.Representatives of the region’s biggest banks, including the European Banking Federation, are due to discuss their concerns with European Commission officials in a video conference on Thursday, while the umbrella organisation plans to set out its questions in a letter to Brussels. The issues include whether to handle the proceeds of investment sales for Russian clients, how to judge if a company is controlled by sanctioned individuals and managing existing agreements with Moscow’s central bank.The confusion among banks over EU measures against Moscow in response to its invasion of Ukraine could intensify as Brussels is this week discussing a fifth round of restrictions to target Russian coal imports and widen restrictions on its banking sector.The commission published a Q&A addressing some of the initial questions raised by the banks in an earlier letter the sector sent to Brussels. EU officials are keen to provide more detailed guidance to the lenders while also addressing the risk of “over-compliance”, in which lenders take an overzealous approach to sanctions.One worry is that banks could refuse to hold deposits for Russian residents of the EU, when current sanctions only prevent the bloc’s banks from accepting new deposits of more than €100,000 from Russians who do not also have an EU passport. “You tend to err on the side of prudence,” said a senior European banker.Two types of “over-compliance” are raising concerns, said a commission official: “One is excessive compliance by member states, who might be excessively cautious and address issues that may not be entirely covered by sanctions.“Then there can be over-compliance by banks, for example discontinuing deposits by Russian customers even if they are resident here and not captured by the sanctions. Firms might take decisions to preserve their reputation or limit risks more broadly; this is not only about sanctions,” the official added. Valdis Dombrovskis, the commission’s executive vice-president, told the Financial Times: “Clearly we understand there needs to be some guidance to banks and institutions that are applying sanctions and we are looking at this.”One of the main worries of the bigger European banks with operations across the globe is that they are being pulled in different directions because of a lack of harmony between EU, US and UK sanctions on Russia.While western countries have attempted to co-ordinate their measures, the banks say there are important differences. For instance, the key question of whether an entity is controlled by people or companies on the sanction list is defined by the US as whether they own 50 per cent or more, but the EU defines it as more than 50 per cent.If two sanctioned people or entities together own more than half of a company, the EU and US consider that to count as control, but the UK does not.Furthermore, the UK does not consider secondary trades in shares of a sanctioned company as breaching sanctions, but the US does and the EU does in some cases.Some banks are also unsure what they should do with repurchase agreements where the counterparty is the Russian central bank, which is now subject to sanctions. Repurchase agreements are a way for banks to raise money or to provide financing by securing a loan against an asset.Banks are seeking guidance on whether they should try to unwind repurchase agreements with the central bank by returning funding or liquidating assets. If such unwinding transactions were considered to be in breach of sanctions, those agreements would be effectively frozen.There is also concern among lenders about trading and investment accounts they hold on behalf of Russians. The banks want clarity on whether the Russian client selling investments worth more than €100,000 would breach sanctions.The EBF declined to comment on the issues.“Given the scale of sanctions, demands for clarification were important and the risk of varying interpretations significant,” said the commission official. “This is why we put out FAQs. This is also why we are reaching out with business associations and stakeholders.” More