Raphael Stevens

America’s driving season has officially begun. Despite rising inflation and the lingering threat of the pandemic, motorists hit the highways with gusto over the recent Memorial Day long weekend. Some 40m Americans travelled by road, an increase of 8.3% on the same weekend a year earlier. That wanderlust came even as prices at the pump were about 50% above last year’s levels, driven by an intense squeeze on global refining.In normal times, the refining business is a low-margin, low-drama adjunct to the geopolitically charged upstream business of oil production and the politically charged downstream business of retail sales. Refiners typically make profit margins of $5-10 a barrel and often go through painful spells of unprofitability. This time, however, refining is playing a starring role—the machinations of the oil-producing countries, war in Ukraine and sanctions on Russian oil exports notwithstanding. Margins for many refiners have rocketed, and bottlenecks in the sector are propelling global petrol prices upwards. Three factors explain why refining is in the limelight. The first is a long-term decline in investment in advanced economies. With oil demand in the rich world forecast to plunge over the next two decades, investors are unwilling to spend many billions of dollars on facilities that could become stranded assets. Adding to this is environmental pressure on refining, which is seen as especially dirty, and regulations in California and Europe that favour greener fuels. Outside China and the Middle East, where capacity is expanding, refining capacity has plunged by some 3m barrels per day (bpd) since the start of the pandemic, reckons Alan Gelder of Wood Mackenzie, an energy consultancy. The second factor that has roiled the refining business is Chinese policymaking. China has historically been a net exporter of refined products, sending large volumes to other Asian countries. In an attempt to fight local pollution and help meet climate targets, however, officials have cut export quotas for big refiners of gasoline, jet fuel and other products by more than 50% this year. On official plans, China is set to stop exporting most carbon-intensive refined products altogether by 2025. The perverse result is that it is sitting on roughly 7% of global spare capacity even as the rest of the world thirsts for transport fuels. The third big disruptive force is, of course, Russia’s war in Ukraine and the resulting sanctions imposed on its exports of hydrocarbons. America and Britain have banned purchases of Russian oil; the eu has announced a partial embargo on crude imports, including one on refined products later this year. The effect of all this is not clear-cut. By widespread accounts (including from tanker-tracking experts), Russia is now exporting more crude oil than it did before the war. It is selling lots of cut-rate crude to India in particular, which is importing over 700,000 barrels a day more than it did before the invasion. When it comes to refined products, though, both official sanctions and the voluntary “self sanctions” embraced by Western firms seem to be biting. According to Natasha Kaneva of JPMorgan Chase, a bank, Russia is selling roughly 500,000 fewer barrels of refined product a day than it was before the war, and may have been forced to shut down as much as 1.4m bpd of refining capacity in May. The result is an unprecedented shift, argues Richard Joswick of s&p Global, a research firm: “The world has plenty of refining capacity, but the spare capacity is moving into Russia and China.” As a result, he reckons that utilisation rates for refiners in the rest of the world will be much higher than previously envisioned. The refining crunch could continue for a while yet. The coming Atlantic hurricane season, which is forecast to be stronger than normal, may shut down refineries in the Gulf of Mexico. Another factor is the precise timing and intensity of Europe’s latest round of sanctions on Russian oil exports. If implemented aggressively, these could further squeeze the sector. Market forces could yet save the day. The painful price spikes seen at petrol pumps will eventually cool demand a little, and could lead to improvements in energy efficiency, both of which will help balance markets. A shift in trade flows could also come to Europe’s aid. India’s world-class refiners, for instance, are turning global crisis into local opportunity. rbc Capital Markets, an investment firm, reckons that the country “is becoming the de facto refining hub for Europe”. Big new refineries are scheduled to come online soon in Kuwait and Saudi Arabia, which should help ease the shortages too. As Mr Joswick observes, “With margins this large, everybody has an incentive to run refineries flat out.” ■For more expert analysis of the biggest stories in economics, business and markets, sign up to Money Talks, our weekly newsletter. More

Tired, old stereotypes portray Canada as the frigid north, awash in maple syrup, hockey and politeness. In the financial world it has earned a more novel, racier reputation: as home to a giant housing bubble. Canada’s property market has soared for the past two decades, shrugging off the global financial crisis of 2007-09 and outperforming most other countries throughout the covid-19 pandemic. Lately, though, cracks have started to appear. In Toronto prices have fallen for three consecutive months. Throughout the country, home sales have plunged. Many economists warn that worse lies ahead.Canadians may scoff at such doomsayers. After all, bubble talk is nothing new, with economists blaring warnings since at least 2010. Nevertheless, a comparison between Canada and other rich countries should give rise to some concern. Since 2000 the average house price has more than tripled in Canada; in America, by contrast, it is up by just about 60% (see chart). The median home in Canada costs ten times the median household income, the highest multiple since at least 1980. Within the oecd, a club of mainly rich countries, only New Zealand has seen house prices increase at a faster rate relative to incomes over the past two decades.The trigger for the recent fall in sales is the same thing hitting markets from America to Australia: inflation. The Bank of Canada, like its peers elsewhere, is raising interest rates in order to tame consumer prices. That has increased mortgage costs, making homes even less affordable. In Toronto, monthly mortgage payments at the median home price gobble up an astonishing three-quarters of median household income, according to the National Bank of Canada, a commercial lender. A rule of thumb is that mortgage payments should be just about a third of income. Little wonder that transactions are way down.More uncertain is the impact on sentiment. Ron Butler, a mortgage-broker in Toronto, has quipped that a “fear of missing out” is giving way to a “fear of getting screwed”. Storeys, a property website, reports that some buyers have started backing out of deals. Prices could have some distance to fall. Robert Kavcic, an economist with bmo Capital Markets, an investment bank, estimates that real home prices are 38% above their long-term trend, the widest deviation in four decades.Bullishness about Canadian property has long rested on two pillars: a shortage of housing, especially in big cities, and an influx of immigrants. Like any good story, though, things get exaggerated. Investors, including speculative punters, now account for one in five house purchases, according to the central bank. The government wants to cool the fervour. It has announced a two-year ban on property purchases by foreigners. More important, developers are ramping up. Units under construction are at a record high. Tony Stillo of Oxford Economics, a research firm, reckons Canada will add 2.35m new homes this decade, outstripping an expected 1.9m new households. In Carleton Place, the fastest-growing town in Canada, half an hour outside Ottawa, both the insatiable demand and the hefty supply response are on display. In a new neighbourhood being built by Olympia Homes, buyers move in as soon as homes are ready. Mark Fillier, a resident since November, says he is still waiting for contractors to add the finishing touches. “They just get the houses up and move on to the next one,” he says. At the end of his street builders are working on dozens of new homes.The key question is how the property sector more broadly—from builders and buyers to lenders and regulators—will adjust to a weaker market. Oxford Economics predicts that Canadian house prices may fall by about a quarter over the next two years. That would probably count as an orderly correction, leaving prices above their pre-pandemic level. Developers would continue to break ground on new homes. And the financial system would remain solid. Canada has long used rules to insulate banks from the property sector: buyers seeking a mortgage must, for instance, have deposits of at least 20% on homes that cost more than C$1m ($795,000).At the same time, though, Canada has vulnerabilities. Household debt is worryingly high: about 185% of disposable income. Given that backdrop, falling house prices could deal a big blow to consumer confidence and weigh on spending more generally. Canada may not be on thin ice. But it is skating into hazardous territory. ■For more expert analysis of the biggest stories in economics, business and markets, sign up to Money Talks, our weekly newsletter. More

When the Federal Reserve raises interest rates, the effects are felt far and wide. Capital shifts in and out of the huge stock of global dollar-denominated assets. The Fed is expected to act forcefully over the next year, raising rates to around 3%, the highest level since early 2008. But this time the response of the biggest foreign holders of dollar assets, particularly those in Asia, could hold surprises. A burgeoning group of large private institutions is changing, and potentially complicating, the picture.Ten years ago “official” foreign investors—mainly central banks managing their currency reserves—held $3.4trn in American Treasuries, about three-quarters of all Treasuries held abroad. Anyone wanting to understand the huge flows in and out of dollar bonds therefore kept an eagle eye on the big reserve managers. There has been plenty of movement of late. China’s reserves—the largest single foreign stash of Treasuries—fell by $68bn in April, 2% of the total and the largest monthly drop in more than five years. Japan’s reserves declined by $31bn, the biggest-ever monthly fall. India’s reserves shrank by $26bn in March, the most since the market panic of October 2008. Those in South Korea and Taiwan have fallen, too. Reserve managers are a tight-lipped bunch, and rarely explain precisely why their holdings have changed. But some of the recent declines are likely to reflect simple valuation effects. The dollar has strengthened; as a result, holdings denominated in other currencies, such as the euro, are worth fewer dollars. Some reserve managers have also intervened in the market by selling their holdings in order to limit currency depreciation. Yet this presents an increasingly partial picture of capital flows. Asian private institutions that cater to ageing populations, such as pension funds and insurers, have exploded in recent years. The assets of Taiwan’s life insurers alone, for instance, have more than doubled in less than a decade. Rather like central banks, these tend to buy and hold safe government bonds and liquid corporate debt.As a consequence, the share of Treasuries owned by official investors has fallen, to 58% of all Treasuries held abroad. Private foreign holdings make up the rest, and have risen from $1.1trn to $2.8trn over the past decade. Sales and purchases of Treasuries by private investors can swamp those made by official investors, as recent trends have made clear. Official investors sold $36bn in Treasuries to American punters in the first three months of this year. That looks measly compared with the purchases made by foreign private investors. They snapped up $235bn in Treasuries, the biggest haul in any quarter on record. This divergence makes sense. Reserve managers get out of Treasuries when American interest rates climb, to protect their currencies from a stronger dollar. Private investors, enticed by juicier yields on long-dated bonds, dive in. Even quasi-public institutions like Japan’s and South Korea’s mammoth state-pension schemes have goals and risk tolerances that differ from reserve managers. Nonetheless, because most of the newly important institutions grew rapidly during a period of low inflation and rock-bottom interest rates, predicting their actions as circumstances change will not be easy. Things are murkiest of all in China, where the aims of financial institutions and the government’s foreign-exchange managers can dovetail. In 2020 and 2021, for instance, China’s official reserves were curiously stable, raising analysts’ eyebrows. While most other Asian countries with large trade surpluses were reporting surging reserves, China’s rose by less than 5%. That raised the possibility that China was using its banks to intervene in the market: Alex Etra of Exante Data, a research firm, and Brad Setser of the Council on Foreign Relations, a think-tank, have pointed to the surging value of Chinese lenders’ net foreign assets as evidence of hidden intervention. So far this year, though, there is little indication that China has used its state banks to disguise intervention. Interpreting the shifts in capital flows was hardly easy when it involved deciphering the actions of relatively taciturn reserve managers. The new, more crowded field of investors with various holdings, strategies and objectives will give analysts an even bigger headache. ■For more expert analysis of the biggest stories in economics, business and markets, sign up to Money Talks, our weekly newsletter. More

It is fashionable in some circles to lament the “cult of gross domestic product”. The pursuit of growth, this criticism goes, blinds officials to less quantifiable but worthier objectives, be it a contented population or a clean environment. For many economists, the concern about gdp is very different. They see huge value in the core mission of the measure: namely, to provide as timely and accurate a snapshot of the state of the economy as possible, a lodestar for governments setting policies and for companies making decisions. Their criticism instead is that gdp occasionally struggles to achieve this, and that better alternatives might exist. This debate has again come to the fore in America because of an unprecedented gap between gdp and its close relative, gross domestic income (gdi). In theory the two ought to be aligned. gdp tracks all expenditure in the economy, summing up the market value of consumption, investment, government spending and net exports in a specific period. gdi tracks the earnings associated with that expenditure, summing up wages, profits and any other income. In reality the two never match up perfectly, since the long-suffering bean-counters in statistical agencies must draw on different sources, released at different times, to tot them up.The gap between gdi and gdp (officially known as “the statistical discrepancy”) is typically about 1%. Since late 2020, however, the discrepancy has been much larger. In the first quarter of this year America’s gdi was fully 3.5% larger than its gdp. That is much more than a rounding error. As Ben Harris and Neil Mehrotra of the Treasury Department wrote on May 26th, when the latest gdi data were released, it results in remarkably different pictures of the economy. If gdp is the better reflection of reality, economic output is still about 2% below its pre-pandemic trend. If gdi is accurate, the economy is 1.2% above trend, a far stronger recovery.One approach to reconciling gdp and gdi is just to split the difference. In 2015 the Council of Economic Advisers in Barack Obama’s White House laid out the case for doing so, calling the average the “gross domestic output” (gdo). The crucial point is that both gdp and gdi derive from entirely independent gauges of output. Combining them should, on average, reduce measurement errors. Mr Obama’s advisers found that gdo was an excellent predictor of later revisions to gdp. For instance, when gdo growth is half a percentage point faster than gdp growth, it is associated with a subsequent upward revision to gdp growth by roughly half a percentage point. This observation is slowly creeping into mainstream thinking. The Bureau of Economic Analysis has started publishing the simple average of gdp and gdi, though few journalists or analysts bother to mention it in their reports.Accounting for the huge discrepancy at present is somewhat trickier. A useful starting point is the observation that the gdi-gdp gap opened up at the height of the covid-19 pandemic as the government’s stimulus flowed into the economy. The sudden infusion of cash through transfers to households and loans to businesses appears to have messed up conventional measures of economic activity. Corporate profits have been uncharacteristically strong, explaining the vigour in gdi. In principle that should have been mirrored in much more robust gdp readings, too.Matthew Klein, the author of “The Overshoot”, an economics newsletter (and who worked at The Economist a decade ago), reckons that an undercounting of business investment in gdp may be the most likely cause. Statisticians have struggled to keep tabs on all the newfangled ways that companies spend money, from software to cloud computing. During the pandemic entire business models were upended to accommodate online shopping and remote working; it stands to reason that investment data may have failed to capture such spending.Another possibility, running in the opposite direction, is that incomes have been overstated. Some people and even businesses may have mistakenly inflated their incomes, at least in a statistical sense. Dean Baker of the Centre for Economic and Policy Research, a left-leaning think-tank, noted back in 2011 that there was a correlation between asset bubbles and gdi. When the stockmarket soars, as it did during much of 2020 and 2021, gdi tends to outstrip gdp. Capital gains are not supposed to count as income in gdp calculations, as they reflect the prices of existing assets rather than production of new ones. But the pattern suggests that people sometimes may misreport capital gains as ordinary income.Nerds to the rescueThe uncertainty about whether to blame the discrepancy on undercounted business investment or overstated income does seem to argue in favour of the simple gdi-gdp average as a measure of economic output. That, however, is not entirely satisfactory. In a paper in 2010, Jeremy Nalewaik, then an economist with the Federal Reserve, showed that gdi was generally closer to the mark than gdp in registering fluctuations in the business cycle. It did a better job of documenting the true extent of the downturn in 2007-09. Moreover, its outperformance relative to gdp over the past two years is also more consistent with the run-up in inflation. Policymakers who had paid more attention to gdi may have become more concerned sooner about economic overheating.Frustratingly, initial gdi estimates come out a month after the first gdp figures. But researchers are on the case. In a paper published in January by the Cleveland Fed, economists pulled together gdp, gdi and a basket of monthly indicators such as the unemployment rate and average hours worked in manufacturing. The result, they hope, is something closer to “true gdp” that can be updated on a monthly basis. Encouragingly, it performed well in documenting the recovery from the pandemic. If it proves itself over time, it will be one more in a dizzying array of indicators to keep track of. But the message is clear: a focus on conventional gdp alone is unduly restrictive at best, and misleading at worst. ■Read more from Free Exchange, our column on economics:Should China spend more on infrastructure? (Jun 2nd)How economic interdependence fosters alliances and democracy (May 28th)How to unleash more investment in intangible assets (May 21st)For more expert analysis of the biggest stories in economics, business and markets, sign up to Money Talks, our weekly newsletter. More

Iconic hip-hop artists are rarely mentioned alongside Warren Buffett or Benjamin Graham as sources of investing wisdom. But Wu-Tang Clan’s 1994 hit “C.R.E.A.M.” immortalised a saying all investors should be familiar with: Cash Rules Everything Around Me. For much of the post-pandemic boom in equity markets, cash and the gauges of corporate valuation that are associated with it were deeply out of fashion. Money was cheap, nearly free, particularly for technology companies. Investors tripped over each other to finance fast-growing startups with only the fuzziest plans for achieving profitability. Some large listed companies reached absurd valuations relative to their ability to generate cash. That has changed dramatically over the past six months. As interest rates have risen, reducing the present value of future profits, a company’s ability to generate cashflows today has become relevant again. This is perhaps causing the most upheaval in tech, where many stocks are priced for profit growth well into the future. That technology stocks have led the recent sell-off is well-known. But the shift goes deeper, as an analysis of their average free-cashflow yield in 2019-21 reveals. This measure takes the money a company generates (after operating expenses and capital investment are accounted for) and divides it by its market capitalisation, providing a gauge of the size of its cash streams relative to market value. Take global listed tech firms that were worth more than $1bn at the start of 2020, and divide them into two groups: the hares, whose valuations raced ahead of their cash-generating ability, resulting in below-average free-cashflow yields; and the more plodding tortoises, with above-average yields. Between the end of 2019 and the peak of America’s nasdaq index in November last year, the share price of the median hare rose by around 24%; the tortoise, by 15%. Since then, however, the hares have tumbled by around 22%, compared with only 8% for the tortoises. Over the two periods as a whole, the cheaper tortoises have outperformed their dearer peers by around six percentage points. The division between the hares and the tortoises is not perfect—though Tesla, for instance, has fallen recently, it has still done spectacularly over the period as a whole, despite relatively low free-cashflow yields. Yet the trend is clear, and extends beyond tech, too. An American exchange-traded fund targeting the 100 companies in the Russell 1000 index with the highest free-cashflow yields is up by about 8% this year. The shift towards a cash-focused equity market will be felt most acutely in tech, however, precisely because it was where the excesses of the previous regime were so evident. The beneficiaries of the new preference for cash generation include hardware firms, such as ibm and hp, the share prices of which have risen since November. These had free-cashflow More

Bosses of major fintech players sounded the alarm about deteriorating macroeconomic conditions at the Money 20/20 Europe trade show.
John Collison, co-founder of online payments firm Stripe, said he was unsure if the company could still justify its $95 billion valuation given the current economic climate.
Zopa, a digital bank based in Britain, suggested it was less likely to meet its target of going public by the end of 2022.

Investment in fintech is slowing as worries around rising inflation and the prospect of higher interest rates have dented economic sentiment.
Elena Noviello | Moment | Getty Images

AMSTERDAM — Financial technology companies are putting IPO plans on hold and cutting expenses as fears of an impending recession cause a shift in how investors view the market.
At the Money 20/20 conference in Amsterdam, bosses of major fintech players sounded the alarm about the impact of a deteriorating macroeconomic climate on fundraising and valuations.

John Collison, co-founder and president of Stripe, said he was unsure if the company could justify its $95 billion valuation given the current economic environment.
“The honest answer is, I don’t know,” Collison said on stage Tuesday. Stripe raised venture capital funding last year and is not currently looking to raise again, he added.
It comes as buy now, pay later firm Klarna is reportedly looking to raise fresh funds at a 30% discount to its $46 billion valuation, while rival group Affirm has lost roughly two thirds of its stock market value since the start of 2022.

IPO delays

Zopa, a digital bank based in Britain, had hoped to go public by the end of 2022. But this is looking less likely as inflation shocks exacerbated by the war in Ukraine have led to a slump in both public and private markets.

“The markets have to be there” for Zopa to go public, CEO Jaidev Jardana told CNBC. “The markets are not there — not for fin, not for tech.”

“We will just have to wait for when the markets are in the right place,” he added. “You only want to do an IPO once, so we want to make sure that we pick the right moment.”
The tech sector has borne the brunt of a market sell-off since the start of the year, as investors digested the likelihood of a steep rate hiking cycle — which makes growth stocks’ future earnings less attractive.
Several executives and investors said rising inflation and interest rate hikes were making it harder for fintech firms to raise money.
“Within the investment community, the mood is very grim,” Iana Dimitrova, CEO of payment software firm OpenPayd, told CNBC.
OpenPayd is in the process of raising funds, but it’s unclear when the company will be able to finalize the round, Dimitrova said.

“People are now definitely moving much slower than they did a year ago,” she said. “They’re being more cautious.”

Funding squeeze

Prajit Nanu, co-founder and CEO of San Francisco-based payments company Nium, said he’s expecting “massive consolidation” in fintech.
“Companies which are not going to raise are going to either get consolidated or shut down,” he said.
The big fear is that fintech growth will slow along with the economy at large as soaring prices force consumers to tighten their purse string. Economists at the World Bank on Tuesday cut their forecast for global economic growth, warning of prolonged “stagflation” — a situation where inflation remains high but growth stalls.

Investment in the fintech sector boomed last year, reaching a record $132 billion globally — thanks in large part to the effects of Covid lockdowns on people’s shopping habits. But — as worries around rising inflation and higher interest rates hit home — funding dropped 18% in the first quarter from the previous three months to $28.8 billion, according to data from CB Insights.
“There’s going to be more of a focus on unit economics versus just crazy growth,” Ricardo Schaefer, partner at Target Global and an early investor in financial services app Revolut, told CNBC.
Stripe’s Collison had a simple piece of advice for fintech founders at the conference: tear up the 2021 investor pitch.
“They definitely can’t do the 2021 pitch,” he said. “It needs to be a new pitch, a 2022 pitch.”
Ken Serdons, chief commercial officer of Dutch payments firm Mollie, agreed. Fintechs seeking fresh funds now will need to present a “clear path to profitability,” he said.

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