Aurelia Butler

Good morning. Today is the first edition of what we hope will become a long-running regular feature in this newsletter: collaborations with our favourite experts on markets, finance and economics. The idea is to introduce Unhedged readers to the best thinkers in our field, and introduce ourselves to new audiences.Ethan and I are frankly not quite sure why our first collaborator would agree to work with us. Adam Tooze is a serious big shot. He is a Columbia professor and a powerful writer on political economy, with books on Covid, the financial crisis, both the world wars, and more. His Chartbook newsletter is a must-read for its combination of deep historical context and granular attention to economic data and the news of the day.Our collaboration with Adam will run today and on the next two Thursdays. Today’s topic: China under pressure. Recent events have raised (not for the first time) questions about the sustainability of the Chinese economic model. Can China make the adjustments necessary to sustain growth, and should global investors go along for the ride? Adam thinks that, with a few provisos, that the answer is yes. Ethan and I think, with a stipulation or two, the answer is no. To lay out these views, we’ve traded places: Adam gives his view below. To see the Unhedged view, follow this link over to Chartbook. And tell us who got it right: [email protected] and [email protected] Tooze: China’s economic transformationThe common starting point for Chartbook and Unhedged is the view that as far as the world economy and financial markets are concerned China remains the big story.This is not to say that Russia’s invasion of Ukraine is not a dramatic shock and the risk of escalation is not terrifying. The impact on energy and food prices will be felt worldwide. But China is a whale. A serious crisis and long-term slowdown there will affect every market and practically every economy worldwide. China is also far more deeply financially interconnected with the rest of the world economy than Russia and Ukraine. China’s economic growth is the driver of what it still the primary geopolitical antagonism in the 21st-century world, that between Beijing and Washington.So the question of China’s growth prospects is a vital one both for policymakers and investors. And this is particularly urgent in light of the signs of serious stress in China’s economy and financial markets.As you can read over at Chartbook today, Robert and Ethan take a pessimistic line heavily informed by the thinking of Michael Pettis and George Magnus.Their view of the short-term is relatively sanguine. As they put it to me in an exchange of emails:The government will apply monetary, fiscal, and regulatory solution adequate to prevent a crisis. Risk of a crisis, financial or economic, is quite low for now.Their pessimism concerns the medium-term growth prospects. Following Pettis, Unhedged sees no way in which China can hit its 5.5 per cent goal without continually piling on more debt. Add demographic headwinds into the mix and they reach a grim conclusion: In the longer term they foresee Chinese growth progressively slowing and its economic relations with the West increasingly been dominated by geopolitical factors, a scenario sketched by Martin Wolf earlier this week.Now, if that becomes the prevalent view — and it is certainly a view gaining significant traction — it has huge implications. The policy world has been buzzing for a while with talk of a fundamental realignment. Are we now about to witness a real economic uncoupling between China and the West?That would be a historic break in global economic development. Look back in 20 years’ time and this moment will stand out as an inflection point.To say the least, this is a big macro call. So, let us stand back a bit to take in the scene.***Let’s start with the point on which Chartbook and Unhedged agree. Despite the $300bn mega-bankruptcy of Evergrande, the risk of an immediate 2008-style crisis in China is slight.But rather than moving on to focus on the medium-term prospects, let us linger over the significance of this point. What China is doing is, after all, staggering. By means of its “three red lines” credit policy, it is stopping in its tracks a gigantic real estate boom. China’s real estate sector, created from scratch since the reforms of 1998, is currently valued at $55tn. That is the most rapid accumulation of wealth in history. It is the financial reflection of the surge in China’s urban population by more than 480mn in a matter of decades.Throughout the history of modern capitalism real estate booms have been associated with credit creation and, as the work of Òscar Jordà, Moritz Schularick and Alan M. Taylor has shown, with major financial crises.Real estate booms don’t generally end in a whimper. They end in a bang. They end with major banking crises.So, if we are agreed that Beijing looks set to stop the largest property boom in history without unleashing a systemic financial crisis, it is doing something truly remarkable. It is setting a new standard in economic policy.What should western investors think about that? Frankly it is not easy to tell because investors have never had to deal with a regime that has attempted anything like it.Is this perhaps what policy looks like if it actually takes financial stability seriously? And if we look in the mirror, why aren’t we applauding more loudly?Add to real estate the other domestic factor roiling the Chinese financial markets: Beijing’s remarkable humbling of China’s platform businesses, the second-largest cluster of big tech in the world. That too is without equivalent anywhere else.The Biden administration and Congress are now talking about big tech, but so far the results are modest. The EU is a serious regulator, but it is nowhere near as menacing as Beijing.If you went all-in on China tech stocks, this is going to hurt. But that is the point. Beijing’s aim is to ensure that gambling on big tech no longer produces monopolistic rents. Again, as a long-term policy aim, can one really disagree with that? So we have two dramatic and deliberate policy-induced shocks of the type for which there is no precedent in the West. Both inflict short-term pain with a view to longer-term social, economic and financial stability.Then there is demography. For obvious reasons, demography is normally treated as a natural parameter for economic activity. But in China’s case the astonishing fact is that the sudden ageing of its workforce is also a policy-induced challenge. It is a legacy of the one-child policy — the most gigantic and coercive intervention in human reproduction ever undertaken.So, Beijing’s challenge right now is to manage the fall out from the two most dramatic development policies the world has ever seen, the one-child policy and China’s urbanisation, plus the historic challenge of big tech — less a problem specific to China than the local manifestation of what Shoshana Zuboff calls “surveillance capitalism”.So, yes, Beijing has its hands full. That creates turbulence for investors. And, no, Xi’s regime has not yet presented a fully convincing substitute plan. But, as Michael Pettis has forcefully argued, China has options. There is an entire range of policies that Beijing could put in place to substitute for the debt-fuelled infrastructure and housing boom.First and foremost China needs a welfare state befitting of its economic development. As Brad Setser explained before he disappeared into the boiler room of the Biden administration, rebalancing the Chinese economy needs to start with a stronger domestic safety net.China needs to spend heavily on renewable energy and power distribution to break its dependence on coal. If it needs more housing, it should be affordable. All of this would generate more balanced growth. 5 per cent? Perhaps not, but certainly healthier and more sustainable.Nor is Beijing unaware of these options. Indeed they have been repeatedly mapped out. If it has not so far pursued an alternative growth model in a more determined fashion, some of the blame no doubt falls on the prejudices of the Beijing policy elite. But even more significant are surely the entrenched interests of the infrastructure-construction-local government-credit machine, in other words the kind of political economy factors that generally inhibit the implementation of good policy.The problem is only too familiar in the West. In Europe and the US too, such interest group combinations hobble the search for new growth models. In the United States they put in doubt the possibility of the energy transition, the possibility of providing a healthcare system that is fit for purpose and any initiative on trade policy that involves widening market access.Ultimately political economy determines the conditions for long-run growth. So if you had to bet on a regime, which might actually have what it takes to break a political economy impasse, to humble vested interests and make a “big play” on structural change, which would it be? The United States, the EU or Xi’s China?***On balance, if you want to be part of history-making economic transformation, China is still the place to be. But it is undeniably shifting gear. And thanks to developments both inside and outside the country, investors will have to reckon with a much more complex picture of opportunity and risk. You are going to need to pick smart and follow the politics and geopolitics closely.Investing in the old model of growth in China is no doubt a dubious proposition. You have to ask what motivated all the smart folks at Western banks and asset managers to continue to build their positions in Evergrande even in 2021.If on the other hand you want to invest in the green energy transition — the one big vision of economic development that the world has come up with right now — you simply have to have exposure to China, whether directly or indirectly by way of suppliers to China’s green energy sector. China is where the grand battle over the future of the climate is going to be fought. It will be a huge driver of innovation, capital accumulation and profit, the influence of which will be felt around the world. Significantly, it is one key area that both the Biden administration and the EU would like to “silo off” from other areas of conflict with China.***In the meantime, I worry that we may be too focused on the medium-term. Given the news out of Hong Kong and mainland China, Covid may yet come back to bite us.Here too China is boxed in by its own success. It has successfully pursued a no-Covid policy, but due to the failing of the rest of the world, it has been left to do so in “one country”. That now comes with serious costs. Authorities in Shanghai are frantically denying rumours of a citywide lockdown.Anyone who shows any schadenfreude at this situation demonstrates only that they have learned nothing. A Hong Kong-style outbreak could mean a terrible toll of excess deaths and the risk of incubating new and more dangerous variants. Until China finds some way to contain the risks, this is a story to watch. A dramatic Omicron surge across China would upend the entire narrative of the last two years, which is framed by Beijing success in containing the first wave.One good readNo, really, read Chartbook! More

Some of the world’s most respected oil traders have predicted crude prices could climb beyond $200 a barrel this year owing to a growing international boycott of Russia and a lack of alternative sources of supply. Pierre Andurand, one of the sector’s best-known hedge fund managers, said supplies of Russian oil into Europe would disappear in the aftermath of Vladimir Putin’s invasion of Ukraine, leading to a lasting reshaping of global energy markets.“Wakey, wakey. We are not going back to normal business in a few months,” he told the FT Commodities Global Summit in Lausanne. “I think we’re losing the Russian supply on the European side for ever.” Crude could even hit $250 barrel this year, double current levels, he said.Other veterans of the oil market speaking at the conference agreed that Russian crude and refined products such as diesel would not return to the European market any time soon, even if a ceasefire with Ukraine were agreed. Analysts have estimated as much as 3mn barrels a day of Russian oil could be lost from the market.Doug King, head of RCMA’s Merchant Commodity Fund, predicted that oil prices would soar to between $200 and $250 a barrel this year. “This is not transitory. This is going to be a crude supply shock,” he said.Brent, the international oil marker, hit $122 a barrel on Wednesday ahead of a meeting between EU and Nato leaders in Brussels on Thursday that may result in fresh sanctions on Russia. Prices stretched as high as $139 immediately after the invasion of Ukraine, and even after the pullback from there, they stand 90 per cent above their level at this point last year.“I don’t think given the way things are going, this is a temporary problem,” said Alok Sinha, global head of oil and gas at Standard Chartered. “You now have to deal with this as a long term issue which means you need to find alternative supply growth.”Daniel House, senior crude trader at Socar, the Houston-based trading division of Azerbaijan’s national oil company, said the US shale oil industry was unlikely to ride to the rescue by cranking up production to pull prices down.[Even] if they wanted to speed up, it’s a 12-month process,” he said, adding that some producers could take as long as 18 months to bring on new oil. “The cavalry is not coming as quickly as it did when we had previous incentives for them to grow”.The US shale industry was once known for its debt-fuelled production binges but executives have since pledged not to outspend cash flow and burn through capital on costly projects.

King said oil prices in the futures market would need to rise significantly before the US shale industry could increase production and deliver the cash returns expected by investors. The contract for US benchmark WTI, for delivery in December 2024, was trading below $80 a barrel on Wednesday.Ben Luckock, co-head of oil trading at Trafigura, predicted a peak Brent crude price of $150 a barrel this summer and warned that developing economies with less ability to reduce fuel taxes would be hardest hit.“Whilst the US, western Europe and wealthier countries in the world will be able to afford some of these tax breaks, print some money . . . those poorer nations won’t have the same toolbox,” he said. “These are going to be the people who suffer first and these are some of the unintended consequences of the policies that are likely to come.” More

The writer is co-founder and co-chair of Oaktree Capital ManagementPowerful investment themes sometimes emerge in a link between seemingly unconnected events. The breakout of war in Ukraine has revealed such a theme, and I believe it is one that investors should heed.At a recent meeting of the Brookfield Asset Management board that I sit on, a discussion of Europe’s reliance on Russian energy commodities triggered an association with another aspect of international affairs: offshoring. At first glance, these two issues may seem to have little in common. But, as I wrote in my latest memo, I think juxtaposing them is informative.The desire to punish Moscow for its unconscionable behaviour is complicated enormously by Europe’s heavy dependence on Russia to meet its energy needs: it supplies roughly one-third of Europe’s oil, 45 per cent of its imported gas and nearly half its coal.Thus, the sanctions on Russia include an exception for sales of energy commodities. In effect, we are determined to influence Russia through sanctions — just not the potentially most effective one, because it would require substantial sacrifice in Europe.Europe appears to have allowed its dependence on energy imports to increase so greatly (especially those from Russia) because it wanted to be more ecologically responsible at home. Security does not seem to have received much consideration.But choosing to rely on a hostile neighbour for essential goods is like building a bank vault and contracting the mob to supply it with guards. The downside of Europe’s reliance on Russian oil and gas has made its way into the consciousness of many people only recently. But the negative effects of the other subject I focused on — offshoring — have been on people’s minds for much longer.Over recent decades, many industries moved a significant percentage of their production offshore, bringing down costs by using cheaper labour. This process boosted economic growth in the emerging nations where the work was done, increased savings and competitiveness for manufacturers and importers, and provided low-priced goods to consumers.But offshoring also led to the elimination of millions of US jobs and the hollowing out of the manufacturing regions and middle class of our country.Moreover, the supply chain disruption that has resulted from the Covid-19 pandemic has revealed the vulnerabilities created by offshoring. Supply has been unable to keep pace with elevated demand as economies have recovered.Semiconductors present an outstanding example of this trend. By 2020, the US and Europe were responsible for only 20 per cent of global semiconductor production, down from roughly 80 per cent in 1990. The world is dependent on Taiwan Semiconductor Manufacturing Company and South Korea’s Samsung for advanced chips. And the ongoing shortage in such chips has highlighted the danger of this.So what is the connection between Europe’s energy emergency and the chip shortage? While they differ in many ways, both are marked by inadequate supply of an essential good demanded by countries or companies that permitted themselves to become reliant on others.Europe’s importation of oil and gas from Russia has left it vulnerable to a hostile, unprincipled nation (worse in this case, to an individual). Offshoring similarly makes countries and companies dependent on their positive relations with foreign nations and the efficiency of our transportation system.The recognition of these negative aspects of globalisation is causing the pendulum of companies’ and countries’ behaviour to swing back toward local sourcing.If the pendulum continues to move for a while in the direction I foresee, there will be ramifications for investors. Globalisation has been a boon for global gross domestic product, the economies it has lifted and the companies that benefited from reduced costs by buying abroad.The swing away will be less favourable in those respects. However, it may improve importers’ security, increase the competitiveness of onshore producers and the number of domestic manufacturing jobs, and create investment opportunities in the transition.For how long will the pendulum swing away from globalisation and towards onshoring? The answer depends on how the current situations are resolved and on which force wins: the need for dependability and security or the desire for cheap sourcing. After many decades of globalisation and cost minimisation, I think we are about to find investment opportunities in the swing towards reliable supply. More

Russia’s invasion of Ukraine will reshape the world economy and further drive up inflation by prompting companies to pull back from their global supply chains, BlackRock’s Larry Fink has warned.“The Russian invasion of Ukraine has put an end to the globalisation we have experienced over the last three decades,” Fink wrote in his annual chairman’s letter to shareholders of BlackRock, which oversees $10tn as the world’s largest asset manager. While the immediate result has been Russia’s total isolation from the capital markets, Fink predicted “companies and governments will also be looking more broadly at their dependencies on other nations. This may lead companies to onshore or nearshore more of their operations resulting in a faster pull back from some countries.”“A large-scale reorientation of supply chains will inherently be inflationary,” Fink wrote, in a wide-ranging 10-page letter that also addressed the invasion’s effect on the energy transition and cryptocurrencies, and updated investors on BlackRock’s business lines and the reopening of its main offices.The letter did not mention any specific country that would be hurt by the shifts, but Fink wrote that “Mexico, Brazil, the United States, or manufacturing hubs in southeast Asia could stand to benefit”. Other investors have argued that the last group could substitute for China, where BlackRock last year launched a set of retail investment products. Fink has advocated for companies in which BlackRock invests to do more to address climate change. His letter predicted that the Russian invasion will affect the transition to cleaner energy. Initially, the search for alternatives to Russian oil and natural gas “will inevitably slow the world’s progress toward net zero [emissions] in the near term,” he wrote.“Longer-term, I believe that recent events will actually accelerate the shift toward greener sources of energy” because higher prices for fossil fuels will make a broader range of renewables financially competitive, he wrote.Though climate activists want investors to shun fossil fuels entirely, Fink rejected this approach, as he did in his January letter to chief executives. “BlackRock remains committed to helping clients navigate the energy transition. This includes continuing to work with hydrocarbon companies,” he wrote. “To ensure the continuity of affordable energy prices during the transition, fossil fuels like natural gas will be important as a transition fuel.”In one of his first comments on cryptocurrencies, Fink drew attention to the Ukraine war’s “potential impact on accelerating digital currencies . . . A global digital payment system, thoughtfully designed, can enhance the settlement of international transactions while reducing the risk of money laundering and corruption.”

He told investors that owing to increasing client interest, BlackRock was studying digital currencies and the underlying technology.Fink commiserated with his shareholders over a rocky start for financial markets this year, in which BlackRock shares are down nearly 20 per cent. “I share your disappointment in our stock’s performance year-to-date. But we’ve faced challenging markets before. And we’ve always managed to come out better and more prepared on the other side,” he wrote.He also noted that the company is coming off “the strongest organic growth in its history” in 2021 when buoyant markets and rising interest in alternative assets and exchange traded funds brought $540bn of net inflows.Looking ahead, Fink made clear that BlackRock wants employees back in the office but will not be among those employers who insist on a complete return to pre-pandemic norms. “Working together, collaborating and developing our people in person is essential for BlackRock’s future,” he wrote. “There are certain conversations that can’t be replicated on a video call . . . We lose the space, the creativity, and the emotional connectivity that come from being together in person”. “At the same time, we recognise the pandemic has redefined the relationship between employers and employees. To retain and attract best-in-class diverse talent, we need to maintain the flexibility of working from home at least part of the time,” he said. More

“Concerns that inflation and economic risks at home can intensify simultaneously are mounting as uncertainty in external conditions heightens,” Rhee Chang-yong, a veteran International Monetary Fund official, said in a written speech.His remarks come a day after the presidential office nominated Rhee as the new central bank chief.The uncertainty in external conditions Rhee mentioned includes a quicker normalisation in Federal Reserve’s monetary policy, economic slowdown in China due to the fast-spreading Omicron coronavirus variant and the Ukraine war.”I will elaborate my ideas on the policy and organisational management through the upcoming parliamentary hearing session,” Rhee said. More

TOKYO (Reuters) -Bank of Japan policymakers agreed that consumer inflation may overshoot their expectations if companies pass on rising costs quicker than forecast, minutes of the central bank’s January meeting showed on Thursday.One member said consumer inflation may temporarily hit 1.5%, while another projected a brief rise near the central bank’s 2% target as companies pass on rising raw material costs to households, the minutes showed.”Many companies are feeling the limit of sticking to a business model that was effective deflation. As they change their price-setting behaviour, inflationary pressure may heighten,” one member was quoted as saying.”We’re seeing stock prices rise for companies that hike prices,” another member said. “Price hikes may broaden, and heighten medium- to long-term inflation expectations.”The remarks underscore the increasing attention the BOJ policymakers was putting on rising inflationary pressures, even as they commit to keeping monetary policy ultra-loose to support a fragile economic recovery.Many members said they were closely watching wages, as they make up a big component of service costs and determine to what extent households would swallow price hikes, the minutes showed.”Nominal wage growth must exceed 2% for Japan to stably meet the BOJ’s price target,” one member was quoted as saying.”To change corporate and household perception on future price moves, it’s important to maintain our current powerful monetary easing,” another member said.At the Jan. 17-18 policy meeting, the BOJ raised its inflation forecasts but maintained its massive stimulus with price growth still distant from its 2% target.Japan’s core consumer prices rose 0.6% in February from a year earlier, marking the fastest pace in two years but still well below the BOJ’s 2% target as weak household spending discourages firms from passing on soaring raw material costs.While many analysts expect rising fuel costs to push up core consumer inflation near 2% in coming months, there is uncertainty on whether the increase will be sustained as slow wage growth weighs on consumption.The BOJ has repeatedly stressed its resolve to maintain its massive stimulus for the time being, even as other major central banks eye an exit from crisis-mode policies. More

LONDON (Reuters) -Russia will seek payment in roubles for gas sold to “unfriendly” countries, President Vladimir Putin said on Wednesday, and European gas prices soared on concerns the move would exacerbate the region’s energy crunch.European nations and the United States have imposed heavy sanctions on Russia since Moscow sent troops into Ukraine on Feb. 24. But Europe depends heavily on Russian gas for heating and power generation, and the European Union is split on whether to sanction Russia’s energy sector. Putin’s message was clear: If you want our gas, buy our currency. It remained unclear whether Russia has the power to unilaterally change existing contracts agreed upon in euros.The rouble briefly leapt after the shock announcement to a three-week high past 95 against the dollar. It pared gains but stayed well below 100, closing at 97.7 against the dollar, down more than 22% since Feb. 24.Some European wholesale gas prices up to 30% higher on Wednesday. British and Dutch wholesale gas prices jumped. [NG/EU] Russian gas accounts for some 40% of Europe’s total consumption. EU gas imports from Russia this year have fluctuated between 200 million to 800 million euros ($880 million) a day. “Russia will continue, of course, to supply natural gas in accordance with volumes and prices … fixed in previously concluded contracts,” Putin said at a televised meeting with government ministers.”The changes will only affect the currency of payment, which will be changed to Russian roubles,” he said.German Economy Minister Robert Habeck called Putin’s demand a breach of contract and other buyers of Russian gas echoed the point. “This would constitute a breach to payment rules included in the current contracts,” said a senior Polish government source, adding Poland has no intention of signing new contracts with Gazprom (MCX:GAZP) after their existing deal expires at the end of this year.Major banks are reluctant to trade in Russian assets, further complicating Putin’s demand.A spokesperson for Dutch gas supplier Eneco, which buys 15% of its gas from Russian gas giant Gazprom’s German subsidiary Wingas GmbH, said it had a long-term contract denominated in euros.”I can’t imagine we will agree to change the terms of that.” According to Gazprom, 58% of its sales of natural gas to Europe and other countries as of Jan. 27 were settled in euros. U.S. dollars accounted for about 39% of gross sales and sterling around 3%. Commodities traded worldwide are largely transacted in the U.S. dollar or the euro, which make up roughly 80% of worldwide currency reserves.”There is no danger for the (gas) supply, we have checked, there is a financial counterparty in Bulgaria that can realize the transaction also in roubles,” Energy Minister Alexander Nikolov told reporters in Sofia. “We expect all kinds of actions on the verge of the unusual but this scenario has been discussed, so there is no risk for the payments under the existing contract.”Several firms, including oil and gas majors Eni, Shell (LON:RDSa) and BP (NYSE:BP), RWE and Uniper – Germany’s biggest importer of Russian gas – declined to comment. “It is unclear how easy it would be for European clients to switch their payments to roubles given the scale of these purchases,” said Leon Izbicki, associate at consultancy Energy Aspects. He said, however, that Russia’s central bank could provide additional liquidity to foreign exchange markets that would enable European clients and banks to source needed roubles.Moscow calls its actions in Ukraine a “special military operation.” Ukraine and Western allies call this a baseless pretext.ONE WEEK DEADLINEPutin said the government and central bank had one week to come up with a solution on moving operations into the Russian currency and that Gazprom would be ordered to make the corresponding changes to contracts.In gas markets on Wednesday, eastbound gas flows via the Yamal-Europe pipeline from Germany to Poland declined sharply, data from the Gascade pipeline operator showed.”The measures taken by Russia may also be interpreted as provocative and may increase the possibility that Western nations tighten sanctions on Russian energy,” said Liam Peach, emerging Europe economist at Capital Economics.The European Commission has said it plans to cut EU dependency on Russian gas by two-thirds this year and end its reliance on Russian supplies “well before 2030.”But unlike the United States and Britain, EU states have not sanctioned Russia’s energy sector. The Commission, the 27-country EU’s executive, did not respond to a request for comment.Habeck said he would discuss with European partners a possible answer to Moscow’s announcement. Dutch Prime Minister Mark Rutte said more time was needed to clarify Russia’s demand. “In their contracts it’s usually specified in what currency it has to be paid, so it’s not something you can change just like that,” Rutte said during a debate with parliament.Russia has drawn up a list of “unfriendly” countries corresponding to those that have imposed sanctions. Deals with companies and individuals from those countries must be approved by a government commission.The countries include the United States, European Union member states, Britain, Japan, Canada, Norway, Singapore, South Korea, Switzerland and Ukraine. Some, including the United States and Norway, do not purchase Russian gas.The United States is consulting with allies on the issue and each country will make its own decision, a White House official told Reuters. The United States has already banned imports of Russian energy.($1 = 0.9097 euro) More