Aurelia Butler

Fourteen years ago Zoltan Poszar, a Credit Suisse analyst, learned about the power of financial contagion. Back then, he was working at the Federal Reserve investigating the plumbing of the credit world.When Lehman Brothers collapsed in 2008, he saw how unexamined interlinkages in the market’s financial “pipes” could generate unexpected shocks, particularly in the tri-party repurchase sector (where short-term loans are extended against collateral between multiple parties).Today, however, Poszar is pondering whether a similar chain reaction might occur as a result of western sanctions on Russian institutions. “We are dealing with pipelines here — financial and real,” he recently told clients. “If you jam the flows by making [Russian] banks unable to receive and send payments, you have a problem [like] when a tri-party clearing bank did not return cash to money funds for fear of ending up with an intraday exposure to Lehman.”Investors should take note. Thankfully there is no sign of serious problems in those financial pipes right now, let alone a Lehman Brothers-style shock. Yes, there are hints of stress in some market corners; the gap between the price of cash Bunds and derivatives, say, has swung sharply wider (seemingly because investors are grabbing securities they can use as collateral in deals).European bank shares have sold off, amid fears about their loan exposures to Russia. There is concern that some emerging market funds will dump non-Russian assets to cover losses on frozen Russian holdings. And there is also gossip among traders about whether the dramatic swings in commodity prices or interest rates have wrongfooted some overleveraged hedge funds; memories of the 1998 collapse of the Long-Term Capital Management fund are being revived.Yet what is perhaps most notable about markets this week is how smoothly they have continued to function in the face of unprecedented financial “shock and awe”. This might be explained away by the fact that the overall scale of Russian financial assets is relatively small compared to the global financial system as a whole. However, another important factor is that western regulators and investors are more skilled in dealing with shocks than they were before 2008 — precisely because they have had so much practice with the financial crisis, the Covid pandemic and a decade of quantitative easing. It has become almost normal for risk managers to imagine six (once) impossible things before breakfast, to paraphrase Lewis Carroll. However, it would be dangerous to be too complacent. One reason is that the full impact of sanctions has not really rippled through the system yet; the formal exclusion of seven Russian banks from the Swift messaging system only comes into effect on March 12. Another is that we simply do not know how a freeze of Russian assets will ricochet around interlinked contracts.The main point that investors need to understand, notes Adam Tooze, a professor at Columbia University, is that “Russia’s reserve accumulation, like reserve accumulation by other oil and gas producers such as Norway or Saudi Arabia, is a source of funding in western markets — [and] part of complex chains of transactions that may now be put in jeopardy by the sanctions.” It is hard to track the nature of these chains with precision, since cross-border data on financial flows and counter parties is patchy. Consider, for example, the situation around US treasuries. Back in the spring of 2018 it was widely reported, on the back of US Treasury data, that the Russian central bank had sold $81bn of its $96bn pile of treasuries holdings, apparently to avoid future sanctions. That sounded dramatic. However, Benn Steil and Benjamin Della Rocca, economists at America’s Council on Foreign Relations, later did a forensic analysis of different national data bases. From this, they decided that $38bn of those Russian holdings had simply gone “missing” from the US data; Russia had seemingly “moved [the bonds] outside of the United States to protect against US seizure” — primarily to Belgium and the Cayman Islands. Whether they are still there is unclear, Steil tells me.Yet while these flows are opaque, Poszar has also crunched through (different) arcane data bases, in a bid to track both the $450bn of non-gold foreign exchange reserves recorded on the books of the Russian central bank holds, and the estimated $500bn of liquid investors apparently owned by the Russian private sector.That leaves him guessing that Russian players have “just over $300bn [held] in short-term money market instruments” outside Russia and “about $200bn of this represents the lending of US dollars in the FX swap market”. How these contracts (and other interlinked derivatives deals) will be handled in the face of sanctions is unclear; but lawyers are currently scrambling to find some answers. Don’t get me wrong: by highlighting the risks in this financial pipework I am not predicting a Lehman-style shock. Nor am I suggesting that these dangers are a reason for the west to roll back sanctions. My point, rather, is this: financial war, like the real variety, creates unpredictable aftershocks and collateral damage. It would be naive to think this will only hit Russian [email protected] More

British businesses expect inflation to rise at its fastest pace for five years, according to a Bank of England survey, as the war in Ukraine pushed up energy prices to their highest level in decade.Chief financial officers forecast inflation to rise to 4.8 per cent this year — its highest since the Decision Makers Panel survey began in 2017. The expectation was 4.5 per cent in the DMP’s January survey.Business groups reported that prices rose by an annual rate of 5.4 per cent in the three months to February, twice the rate over the same period last year.The survey, conducted between February 4 and 18 across nearly 3,000 businesses, predated Russia’s attack on Ukraine, which has pushed the price of oil to its highest level since 2008.As a result, Steffan Ball, economist at Goldman Sachs, expects that the consumer energy price cap set by the UK energy authority twice a year will rise by 55 per cent in October. This means “the peak in headline inflation shifts from April to October, rising to 9.5 per cent in October and remaining above 7 per cent through 2023 Q1,” Ball explained. He expects inflation to rise to 8.5 per cent in April, up from 5.5 per cent in January.The DMP survey suggests that domestic price pressures were strong even before the surge in energy prices following the Russian invasion of Ukraine. Monetary policy setters at the Bank of England have often quoted high business inflation expectations from the DMP survey in recent months to support the need for further monetary policy tightening.Earlier this week Michael Saunders, an external member of the BoE’s monetary policy committee, said the expectations of rising prices shown in the survey “threaten to keep CPI inflation above the 2 per cent target even once the effect of high energy effects fade, unless restrained by monetary policy”. Saunders voted for a rate hike of 50 basis points at the BoE’s January meeting, when rate-setters decided to increase the rate by 25 basis points to 0.5 per cent. He said the DMP survey showed that across a wide range of sectors “firms believe they can pass on rapid cost increases to prices.” In an earlier speech, Catherine Mann, a member of the MPC, also said the survey showed that businesses’ pricing expectations had solidified “an upside inflation risk for 2022”.The survey also showed that domestic price pressures were partly caused by widespread labour shortages. In February, nearly 90 per cent of businesses reported they were finding it more difficult to recruit new employees. Nearly 60 per cent of the businesses surveyed reported that recruiting was “much harder”, up 4 percentage points from the previous month.The labour shortages come as businesses continue to hire to deal with current demand. Businesses reported employment to have grown by an annual rate of 3.8 per cent in the three months to February, the fastest pace in nearly five years. Employment growth for the year ahead was 3.1 per cent, close to the five years high of 3.5 per cent reached in September. More

The rapid imposition of economic sanctions on Russia has been impressive in its scale and the unity of action. In time, they will offer the carrot of a path towards normalisation if Moscow credibly ends its aggression against neighbours. Europe must now find ways to minimise its reliance on Russian energy. The sting of economic condemnation is significantly weakened so long as countries need carve outs to ensure the lights stay on and citizens are warm in winter. The wider economic response is also crucial. Russia’s war and the economic response combine to impart a sizeable stagflationary shock on advanced economies, which were previously recovering strongly from the pandemic. Finance ministries and central banks have an extraordinarily difficult task in managing policy in economies already struggling to control inflation.The shock is inflationary because already elevated oil, gas and food prices have jumped, pushing commodity prices to their highest since 2008. It is directly contractionary for industries having to restrict business that is under sanctions. It also indirectly slows growth by squeezing incomes as prices rise, adding reasons for households and companies to be cautious with spending. A stagflationary shock is a nasty dilemma for policymakers. Too little response to inflation will embed rapidly rising prices into corporate expectations of what consumers will tolerate and the pay increases they need to offer. No one benefits from any sort of wage price spiral. But being too concerned about inflation will weaken growth, could cause recessions and, at worst, offer Russia a propaganda victory. The shock to growth seems likely to be more powerful than that to inflation, so whatever monetary or fiscal tightening was planned, the authorities in the US, eurozone and the UK could do a little less now. But everyone has to be nimble because this assessment is tentative and might easily be wrong. Practically, this means the US would make minimal changes to its plans to tighten policy because it has the most intense inflationary pressures and will not be hit as hard by higher energy prices. Indeed, high oil prices tend to encourage US private sector investment. Eurozone central bankers would need to be much more cautious, given this economy is a huge net energy importer and underlying inflationary trends were weaker. The policy dilemma is perhaps most acute in the UK, which has inflation set to rise to over 7 per cent, unemployment at pre-pandemic levels, shortages of labour and still loose monetary and fiscal policies. Just before Russia invaded, the IMF proposed a minor revolution in economics to deal with the UK’s economic circumstances. Raise taxes now rather than later, the fund recommended. It said the action would cool inflation faster than higher interest rates, which have their maximum effect about a year after implementation, and poorer households could be protected by exempting them from tighter fiscal policy. Using fiscal policy as the active tool for damping demand is not something many have suggested since crude Keynesianism went out of fashion. A lively debate about the tools of macroeconomic management has been cut short by Russia’s actions. Now is not a time for economic experiments and tax increases that would intensify the horrible squeeze on incomes faced by UK households. For now, the job of managing the cycle and the trade-off between the inflationary and contractionary effects of this crisis in the UK and elsewhere should fall to central banks.The populations of advanced economies should cut the central bankers some slack as they go about this miserable task. They will do their best to balance inflation and growth, but stagflationary shocks are circumstances where mistakes are highly likely. [email protected] More

With so many mouths to feed, understandably China eyes self-sufficiency of food supply as important. It has successfully stepped up domestic grain production in recent years. But the country has some way to go. Russia’s invasion of Ukraine must worry Beijing given the primacy of Ukrainian exports to Chinese food security.China is the world’s largest agricultural importer. Local production falls short of its needs and Ukraine’s crops help fill the gap. Last year, China imported a record 28mn metric tonnes of Ukrainian corn, more than double from the previous year’s 11mn. Ukraine is blessed with highly fertile black soil — more than a quarter of the global share — enabling it to produce more than 80 per cent of Chinese corn imports. China has little leeway. Its grain supply shortfall should reach about 130mn tonnes in the next three years. Any resulting scarcity of animal feed would cause even more problems for local food inflation. Shortages have already been a problem as extreme weather last year affected local harvests. China’s strict zero-Covid policy has amplified supply chain bottlenecks for imported food products. Last month, before the war began, Beijing had decided to release some edible oils from the country’s central reserves. While prices of imported wheat and corn have already surged to near record levels, soyabeans are the key weakness for China. It relies heavily on imports for more than 80 per cent of its consumption. Higher input costs for fertilisers and energy only exacerbate a tricky situation, putting downward pressure on economic growth. That should mean local food and meat companies face a grim outlook. Yet share prices of these companies, such as Cofco Joycome Foods, Zhengbang Tech and Tingyi Holding, have outrun the broader market indices. They have been perceived as havens during Beijing’s recent tech crackdown. However, soaring raw material prices and disrupted imports should squeeze foodmakers’ profitability. Food security and keeping a lid on inflation is critical this year. President Xi Jinping now prepares to transition into his third term as leader at the National Congress of the Chinese Communist party in the autumn. Thus expect local food companies to take some pain to keep prices down. More

TOKYO (Reuters) – A Tokyo court on Thursday handed former Nissan (OTC:NSANY) Motor executive Greg Kelly a six-month suspended sentence for helping Carlos Ghosn hide pay from regulators, paving the way for the American lawyer to return home after more than three years in Japan.The verdict draws a line under a case that threatened to strain relations between Japan and the United States, its closest ally, over the Japanese justice system’s treatment of Kelly who was arrested alongside the former Nissan boss.”The court finds the existence of unpaid remuneration” and the failure to disclose amounted to “false” reporting, the chief judge Kenji Shimotsu said, telling Kelly he was responsible for one of the eight years included in the charges.”I was shocked by the judgment,” Kelly said in a statement after the ruling. “The court found me mostly innocent, but I do not understand why it said I was guilty for one of the years,” he added.His lawyers said they will appeal the conviction, which Kelly should be able to do from the United States. Both Kelly and Ghosn – who fled to Lebanon in 2019 hidden in a box on a private jet – allege they are victims of a boardroom coup by former colleagues worried that Ghosn wanted to merge Nissan with alliance partner and largest shareholder Renault SA (OTC:RNLSY).In pointed criticism of the prosecutors, the ruling also pinned blame for Ghosn’s alleged failure to disclose $80 million of income over eight years on Toshiaki Ohnuma, a Nissan official overseeing compensation, who was given legal immunity in return for testimony implicating Kelly. “Ohnuma’s statement is fraught with danger that he was making statements that conformed to the prosecutors’ wishes,” Shimotsu said. “There was a danger as an accomplice that he would seek to shift responsibility to Ghosn,” he added.The court also fined Nissan, which pleaded guilty at the start of the trial 18 months ago, 200 million yen ($1.73 million) for its part in the financial wrongdoing and took aim at corporate governance failings. “The dysfunctional governance of the company allowed Ghosn to act in his own self interest. The severe damage to the company’s social reputation can only be described as it suffering the consequences,” Shimotsu said, describing Ghosn’s tenure there as a “dictatorship”. In Beirut, Ghosn described Nissan’s fine as “laughable” and said of Shimotsu’s comment: “It’s like a cartoon comment. I am trying to understand what makes him make this kind of comment when I am not there”He added that Renault (PA:RENA) was struggling because of Nissan’s lack of vision. ‘LONG THREE YEARS’Some Western observers criticised the Japanese justice system’s treatment of Kelly.Suspects in Japan are not allowed to have a lawyer present during interrogations and can be detained for up to three weeks without charge and often in solitary confinement. And 99% of cases that go to trial end with a conviction. “While this has been a long three years for the Kelly family, this chapter has come to an end. He and Dee (his wife) can begin their next chapter in Tennessee,” U.S. ambassador in Japan Rahm Emanuel said in a statement.Kelly testified that his only intent was to give Ghosn, who was also the chief executive at Renault, a compensation package that would dissuade him from defecting to a rival automaker.Bill Hagerty, a U.S. Senator from Kelly’s home state Tennessee, said he planned to welcome his constituent at the airport.”Greg has been subjected to circumstances corporate America could never contemplate,” Hagerty said. “Greg is innocent of the charges levied against him,” he added.The court ruling, however, does not mean an end to legal troubles faced by the former head of Nissan and alliance partner Renault, but it may be the closest the Tokyo court gets to ruling on Ghosn’s culpability. Ghosn is beyond the reach of Japanese prosecutors after while in Lebanon. He is unable to leave without risking arrest. In addition to the charge of hiding his earnings, Ghosn is also accused of enriching himself at his employer’s expense through $5 million of payments to a Middle East car dealership, and for temporarily transferring personal investment losses to his former employer’s books. Ghosn has denied all the accusations against him.($1 = 115.5900 yen) More