Economy

Good morning. Today is the second of three Unhedged x Chartbook collaborations with Adam Tooze. Adam is on the cover of New York magazine this week, which means Ethan and I are famous by proxy. The topic this week is “The End of Globalisation As We Know It”. There has been a loose nexus of arguments cutting across geopolitics, finance and economics in recent years, which suggests that the status quo of the past 30 or 40 years is changing. Old: liberal democracy and free trade rising, low interest rates, low inflation and high equity valuations, especially for technology. New: populism, trade barriers, higher rates and inflation and valuations under pressure.Are we in a true moment of transition? Below, Adam expresses scepticism about the conventional wisdom, most recently expressed in Larry Fink’s annual letter to BlackRock shareholders. Over on Chartbook, Ethan and I argue that there are good reasons to think that tectonic plates are shifting beneath markets and the economy. The changes may be nascent and it is impossible to predict just where they will lead, but all the same, the ground is rumbling. Email us: [email protected] and [email protected] Tooze: Deglobalisation may be more talk than substanceLarry Fink’s annual letter to BlackRock shareholders stirred a flurry of debate last week about Vladimir Putin’s invasion of Ukraine, the future of globalisation, supply chains, inflation and the implications for investors. It is a sign of the times. Fink’s previous letters had been more famous for focusing on the climate crisis and ESG.Now, like the rest of us, Fink and the asset manager feel compelled to react to Russia’s war on Ukraine.The letter diagnoses what I called the “polycrisis” of our times in my book Shutdown (borrowing the phrase from former European Commission president Jean-Claude Juncker).“The ramifications of this war are not limited to eastern Europe,” Fink opines. “They are layered on top of a pandemic that has already had profound effects on political, economic and social trends. The impact will reverberate for decades to come in ways we can’t yet predict.”For Fink, Putin’s aggression puts in question the history that has framed his company’s entire development:In the early 1990s, as the world emerged from the Cold War, Russia was welcomed into the global financial system and given access to global capital markets . . . The world benefited from a global peace dividend and the expansion of globalisation. These were powerful trends that accelerated international trade, expanded global capital markets, increased economic growth and helped to dramatically reduce poverty in nations around the world. It was during this time that we started, 34 years ago, to build BlackRock. We saw the rise of globalisation and growth of the capital markets fuelling a need for the kind of technology-driven asset management that we believed we could bring to our clients.BlackRock launched an initial public offering in 1999, months after the 1998 financial crisis in Russia that helped to bring Putin to power.Now, Fink declares, Russia’s attack on Ukraine “has put an end to the globalisation we have experienced over the last three decades. We had already seen connectivity between nations, companies and even people strained by two years of the pandemic. It has left many communities and people feeling isolated and looking inward. I believe this has exacerbated the polarisation and extremist behaviour we are seeing across society today.”Fink has championed the responsibility of investors to counter these ominous trends through a long-term approach to ESG issues. In reaction to Putin’s aggression, he now advocates something far more radical: a deliberately orchestrated global capital strike.“The invasion has catalysed nations and governments to come together to sever financial and business ties with Russia,” Fink declares. “United in their steadfast commitment to support the Ukrainian people, they launched an ‘economic war’ against Russia . . . These actions taken by the private sector demonstrate the power of the capital markets: how the markets can provide capital to those who constructively work within the system and how quickly they can deny it to those who operate outside of it . . . This ‘economic war’ shows what we can achieve when companies, supported by their stakeholders, come together in the face of violence and aggression.”It is a remarkable call to arms but Fink does not linger over the awesome responsibility it implies. After all, if you call for an economic war against Putin’s regime, why stop there?Instead, he steers us back to more familiar and less edgy territory:Russia’s aggression in Ukraine and its subsequent decoupling from the global economy is going to prompt companies and governments worldwide to re-evaluate their dependencies and reanalyse their manufacturing and assembly footprints — something that Covid had already spurred many to start doing.And while dependence on Russian energy is in the spotlight, companies and governments will also be looking more broadly at their dependencies on other nations.Which “other nations” Fink has in mind is left unspoken. But he goes on to argue that “Mexico, Brazil, the United States, or manufacturing hubs in south-east Asia”, all of which are presumably safe bets, may stand to benefit from the relocation of production.“This decoupling will inevitably create challenges for companies, including higher costs and margin pressures,” Fink warns. This will be “inherently” inflationary.As Fink notes, inflation in the US is at levels not seen in 40 years, which puts huge pressure on lower-wage workers in particular. This leaves central banks facing a “dilemma they haven’t faced in decades. Central banks must choose whether to live with higher inflation or slow economic activity and employment to lower inflation quickly.”Over at Chartbook this morning, Robert Armstrong and Ethan Wu pick up where Fink leaves off. They provide a powerful summary of the forces that promise an end to globalisation as we know it and to accelerate inflation.But, contrasting Unhedged’s data-rich take with Fink’s hand-waving, I was left wondering whether Fink’s vagueness was not actually the point. What if we read the BlackRock letter less as a piece of analysis than as an exercise in corporate diplomacy, which in its evasions signals the opposite of what the headlines suggest?Do we really believe that BlackRock is giving up on globalisation as we know it? After all, Putin with his blatant aggression and angry tirades makes an all-too-convenient hook on which to hang a narrative of the crisis of globalisation.Russia’s actions may be outrageous. But its economic weight is limited. As Fink is only too happy to remind his shareholders, BlackRock has very little money at stake there. From the global point of view, how much is really at stake in an economic war against Russia? Meanwhile, talking about Putin spares Fink the embarrassment of having to talk about the real faultline in the global economy: between China and the US. And if you are, in fact, interested in maintaining your business in China, as BlackRock surely is, the less said about that antagonism, the better.In talking about supply chains, what does Putin’s war in Ukraine really have to do with it? The economic flows which the war put at risk are in commodities (wheat, corn, etc) and energy. As far as supply chains are concerned, the most dramatic disruption is to the provision of wiring harnesses from Ukrainian factories to German carmakers BMW and Mercedes. Important components, no doubt, but hardly the marker of a new era in economic history.As Armstrong and Wu note, we are facing a significant threat to a truly essential supply chain, but in microelectronics, and the challenge is posed not by Russia, but by the US government, which has decided to make tech in to a battleground with China. Like its competitor Vanguard, BlackRock was forced by US sanctions into making painful asset disposals.Much of the US business lobby, Armstrong and Wu point out, has turned against China. But that cannot be said for BlackRock or any other big player in American finance. George Soros may insist that BlackRock is making a strategic mistake in continuing its investment in China, but the asset manager has shown no sign of backing down. Perhaps, then, the talk of the end of globalisation in the wake of Ukraine is smoke and mirrors.Unhedged finishes with a fascinating exchange with Larry Summers (a longstanding supporter of both Unhedged and Chartbook).As Summers pointed out to Armstrong and Wu, however wise or dumb their (pessimistic) view of the future of globalisation and inflation may be, it is not shared by the big players in the markets:Current prices strongly imply the current spike in inflation and rates will subside before very long, and the old world of “secular stagnation” will reassert itself. This is most easily visible in the Fed funds futures curve, which suggests rate increases will stop below 3 per cent some time next year, and that policy will weaken thereafter.BlackRock, in its most recent macro outlook for the second quarter of 2022, shares that common-market perspective.It is a weird form of cognitive dissonance: to talk as though you recognise the headwinds and not price them in. Hoping, perhaps, that they will not, after all, materialise.I would argue that something similar holds for globalisation more generally. There is a lot of talk about reshoring and rebuilding supply chains, but far less action on the substance. Apple, to cite the most prominent example, actually increased its reliance on China last year.For now at least, feverish talk about Russia’s attack on Ukraine ending globalisation as we know it should be taken with a pinch of salt.Imagine Fink championing an economic war against China! When that no longer seems “non-planetary”, we will know that we are really in a new world.One good readDon’t sleep on the US housing market. People looking to buy a home this year “are going to be facing the biggest payment shock that we’ve seen in the last 40-plus years”. More

Good morning and welcome to Europe Express.With the EU-China summit taking place tomorrow, the first time since 2020, we’re exploring why Brussels is treading a finer line than Washington in its relationship with Beijing, even as the transatlantic allies are aligned in trying to dissuade China from siding with Russian president Vladimir Putin in his war in Ukraine.Meanwhile, Germany and Austria yesterday took the first formal steps towards gas rationing in case Russia turns off the tap. But in a call with Germany’s chancellor, Olaf Scholz, Putin hinted at a potential compromise, saying that payments by European gas customers could continue to be made in euros.As calls are mounting for what diplomats call “a fund for everything”, we’ll have a look at the problems maintaining customs revenues, one of the few “own resources” that fuel the EU’s coffers.And with Brussels making another effort at bringing companies and polluting industries to task for their environmental harm, we’ll bring you the latest in what the European Commission is due to put forward next week on this topic.Do no (significant) harm It’s being billed as the most difficult summit the EU has ever held with China, as the European Council and European Commission presidents prepare to deliver a blunt message to Beijing over its relationship with Vladimir Putin, write Sam Fleming and Henry Foy in Brussels. Charles Michel and Ursula von der Leyen will urge President Xi Jinping and Premier Li Keqiang to keep their distance from Russia’s bloody war in Ukraine, warning of the reputational damage that China would suffer if it supported Moscow’s conflict. While they are not planning to deliver explicit threats of sanctions, and officials are not working up penalties at this stage, both the US and the EU are keeping that option firmly on the table as they gauge China’s “no limits” friendship with Russia. Yet despite the tough rhetoric, the EU is going into the discussions with deep trepidation. That is because while the EU’s geopolitical interests are diverging ever more sharply from those of China and Russia, the EU-China economic partnership remains critical to the two sides. China’s gross domestic product is, after all, around 10 times larger than that of Russia. It is the EU’s biggest trading partner, accounting for 16 per cent of EU trade in 2020, compared with less than 5 per cent for Russia. The EU is now engaged in a project to wean itself off Russia’s all-important hydrocarbon exports as rapidly as possible. But it would be far more painful to attempt to unwind the tightly integrated trading relationship with China. The EU-China investment treaty agreed in 2020 remains a distant prospect, and the EU remains focused on hardening its trade defences against China, rather than pursuing deeper integration. But both sides have huge incentives to avoid a fundamental breakdown in their economic relations. Officials make no secret of the fact that while the EU’s relationship with China has become increasingly fractious, it remains a very different one from that of the US, which is engaged in taking a more open adversarial track with Beijing (and pressing the EU to follow suit).The EU presidents, said one official, “agree that we need to continue working with China”. A very clear case will be made that “our economies both gain from the trade relationship, which feeds both societies . . . And the current global turbulence is not good for that.”The goal of the EU-China call, scheduled for tomorrow morning Brussels time, is therefore damage mitigation. The EU is not expecting China to play a positive role in ending the war in Ukraine but it is hoping Beijing will keep its distance. That may seem a singularly unambitious goal but it may be the best the EU can hope for.Chart du jour: German vulnerability

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In past years, China exploited divisions in the bloc, with Germany often prioritising friendly ties with Beijing. But China’s position on the war in Ukraine changed the calculus. (More here) EU seeks refined customsThe calls on the EU’s budget are only growing as the union faces mounting common challenges — including the need to push forward the green agenda, respond to the refugee crisis, decouple from Russian fossil fuels and bolster common defence projects, writes Sam Fleming.Yet the reality is that the budget is based on fragile foundations. Member states have yet to agree the fresh “own resources” — or bespoke revenue lines — that will be needed to repay the common borrowing under the €800bn NextGenerationEU programme, for example. And there are gaps even in the EU’s most long-established streams of revenue. A report from a Wise Persons Group on Customs for the European Commission will today set out the particular problems in the realm of customs revenue — and propose a set of reforms to improve the situation. The recommendations are set to feed into a customs reform package, which the commission will present by the end of this year.The EU in 2020 collected close to €25bn of customs duties, of which €20bn went to the EU budget. But the Wise Persons report, a draft of which was seen by Europe Express, finds that billions of euros remain uncollected. Changes in trade and technology, including the shift to ecommerce, call for a modernisation of the system, it finds. The Wise Persons group, chaired by Arancha González Laya, a former Spanish foreign minister, sets out 10 recommendations to overhaul the system. These include upgrading sources of customs data rather than relying only on declarations, boosting data sharing between authorities, creating a European Customs Agency, while simplifying rates for low-value shipments. “The reality is also that European customs do not yet currently function ‘as one’,” the report finds. “This leaves the Customs Union at the mercy of its weakest link.” Tough on pollutersThe EU wants to toughen up on companies that pollute the environment by setting stricter limits on hazardous waste, requiring better reporting of emissions and imposing harsher penalties on those who breach the measures, writes Alice Hancock in London. The proposals form part of a revision of the EU’s outdated industrial emissions directive and will expand the areas of industry affected by the rules to include a bigger number of livestock farms and large-scale battery manufacturers, according to a draft paper seen by Europe Express.While the industrial emissions directive, which covers around 20 per cent of the EU’s air pollution by mass and around 40 per cent of greenhouse gas emissions, has been “generally effective” in reducing pollutants, the paper says, it is not clear that it has encouraged companies to trial new technologies that prevent emissions, nor that it has done much to decarbonise the bloc.The directive has also not been implemented “homogeneously” across all member states, the draft suggests.It has been a busy week for green policy in Brussels. The European Commission published a package of proposals yesterday intended to promote a “circular economy”. These include better recycling of textiles and an extension of energy-efficiency labels commonly seen on white goods to almost all consumer products.The extension of the industrial emissions directive, due to be published on April 5, would ensure that European citizens have better access to information on pollution from heavy industry and that they would be able to take action against companies and demand compensation if their health was affected.Mohammed Chahim, a Dutch MEP on the environment committee, said the proposals marked an important effort to stop hazardous waste at source rather than simply making companies pay for their pollution through the emissions trading system. But Christian Schaible, policy manager for industrial production at the European Environmental Bureau, said the directive “falls short” of pushing industry into “a comprehensive shift” towards climate neutrality. It was a “huge blunder” to keep in an article that prevented permits issued to industrial polluters from stipulating limits for greenhouse gas emissions, he added.What to watch today Nato secretary-general Jens Stoltenberg presents his annual report for 2021Ukrainian president Volodymyr Zelensky speaks to the Belgian parliamentNotable, Quotable

Gloomy outlook: Russia’s war in Ukraine is delivering a “supply shock” to the eurozone economy that will push up prices, slash growth and drain consumer and business confidence, says ECB chief Christine Lagarde. Separately, the outlook for the labour market is also worsening by the day, aggravated by rising inflation. Slow bureaucracy: The UK has processed fewer than half of visa applications from Ukrainian refugees, and fewer than 10 per cent of those applying under a scheme that allows British people to volunteer as hosts, the minister for refugees said yesterday.Buy American: Germany opted this month to replace its ageing Tornado fleet with a batch of US-made F-35 fighter jets, prompting dismay in France. Europe’s defence industry is angered that the choice of an American weapons system seemingly goes against bolstering Europe’s own capabilities.Gazprom, raided: Investigators carried out a dawn raid on the offices of Gazprom’s German divisions yesterday, as EU officials seek to understand the Russian company’s possible role in the recent surge in gas prices to record highs. More

Russia’s economy will shrink by 10 per cent this year as the war in Ukraine and western sanctions inflict the deepest recession since the early 1990s, according to the European Bank for Reconstruction and Development.Russian gross domestic product will also flatline in 2023 and suffer very low growth over the long term, the bank said, as overseas buyers reduce purchases of Russian oil and gas, foreign investors shun the country and educated young Russians emigrate. But its financial system had so far withstood the shock of retaliatory measures from the west, it noted.“Russia will take a hit and living standards will take a hit,” said Beata Javorcik, EBRD chief economist. “But they will be able to weather this shock in terms of macroeconomic stability. What is going to impact Russia more is growth . . . zero growth next year and very low growth longer-term.”The EBRD said the war had triggered the “greatest supply shock” since the 1970s, which would have a “severe” impact on low-income countries far beyond eastern Europe.It said measures taken by Russia’s central bank since the country’s invasion of Ukraine last month, including a sharp rise in interest rates and provision of liquidity, have helped stabilise the banking system. But Russia’s energy companies could struggle to pay foreign currency debts as their overseas earnings shrink, potentially causing “a more significant financial crisis”.The EBRD’s updated forecast assumed a ceasefire between Russia and Ukraine “after two-three months but that sanctions will remain in place for the foreseeable future”, Javorcik said.The multilateral bank, which stopped fresh lending to Russia in 2014 after Moscow’s annexation of Crimea, predicted that Ukraine’s war-battered economy would decline by 20 per cent this year. Growth would rebound in 2023 but damage to physical infrastructure estimated by Kyiv at $100bn would leave the country much poorer.Javorcik warned of a brewing crisis for emerging market and lower-income countries. Policymakers will come under pressure to spend more to cushion their populations from higher food prices and energy prices at a time of pressure on emerging market currencies and rising interest rates.“They will have an incentive to continue with subsidies or to even increase subsidies, in a world where public finances are already strained,” Javorcik said.

The World Bank warned this week that the war could push millions of people into poverty and tip poorer countries into a debt crisis.The EBRD said north African economies as well as Lebanon have been particularly exposed to a reduced supply of wheat from Ukraine and Russia, two of the world’s biggest exporters. Some would also suffer from reduced tourist flows from Russia.In Egypt, yields on its dollar denominated government bonds increased in the aftermath of the invasion of Ukraine, reflecting its vulnerability to rising food and energy prices Turkey, which imports more than 90 per cent of its oil and gas needs, would likely see further pressure on the lira, the EBRD said. Russians and Ukrainians account for a fifth of tourists visiting the country.The economic impact of Russia’s invasion would also ripple across central and eastern Europe, the EBRD added, with the Baltic states suffering the greatest hit from disruption to trade. More

From the moment Russia’s tanks rolled across the Ukrainian border, the investment world changed. This is a war between two countries that mainly export commodities.Russia is the world’s largest oil exporter — at the turn of the year it was producing 11.3mn barrels a day, according to the International Energy Agency. It was also the world’s biggest exporter of wheat. Ukraine is another major grain producer. It exported 48mn tons of corn and wheat last year, according to S&P Global’s estimates. Both countries share the same biggest market for their produce — China.With trade to Russia and Ukraine virtually closed off, commodity prices have risen globally. When the price of fuel and food goes up this often heightens political risks in emerging markets, where these commodities are a big part of the daily budget of many households.Wheat prices experienced a similar increase in 2010, when there were droughts in Russia and Ukraine and severe weather-related problems in other grain-producing countries. The Arab Spring followed. Rising food prices were not the only cause, but they helped tip political tension into uprisings.To a global equity manager, emerging markets can offer excellent growth dynamics when conditions are fine. However, the history of investing in emerging markets is marked by occasional crises. Behind many of these is often a political story that begins beyond the borders of the countries affected.So, for instance, there is a current risk of Russia not paying interest on its government debt. The last time this happened was in 1998 under Boris Yeltsin (the previous one being 1917 following the revolution). 1998 is a bleak year in the memory of emerging market investors as many Asian equity markets collapsed. The collapse probably owed more to Brazil and Mexico defaulting in previous years than to the Russian default, but all the same, a Russian default would stir memories. Russia remains a small part of emerging market investing. At the start of this year it accounted for about 4 per cent of the index compared with China at 32 per cent, Taiwan 16 per cent, India 12 per cent, South Korea 12 per cent, Brazil just 5 per cent and others 22 per cent. China therefore rather dominates how much exposure an investor might currently choose in emerging markets — especially if you are a passive investor.

Even before the war in Ukraine, China was presenting difficulties for international investors. Just under a year ago I wrote explaining why my team had decided to sell all our fund’s Chinese investments. We had been monitoring how regulations had started to change in ways which might impede value creation for shareholders. We also noted that shareholders of the major technology companies — such as Alibaba and Tencent — were non-Chinese as the shares were listed outside the mainland and local investors could only invest locally. We were concerned this would lead to scrutiny from Beijing. In November 2020, the public offering of Ant Financial, the fintech side of Alibaba, was cancelled at the last moment. This was expected to have been valued at over $35bn, so a red flag was raised. Over the next few months, a broad range of regulations and some fines were announced, hitting the value of other Chinese stocks from food delivery to education to games companies. Each announcement made good sense in terms of looking after the Chinese people, but many overseas investors inferred that the prospects for growth of China’s most popular listed stocks had been materially lowered. Share prices of targeted businesses plunged.We would not be brave enough to predict that this shift in regulation has ended. Demographic factors arguably put pressure on Beijing to follow through with further action. When I first started investing in China in 2002 there was an economic case to be made for creating manufacturing jobs in the coastal areas and allowing the population to leave the land for these more productive roles. Foreign investment made that possible and was encouraged.

Two decades later, the one-child policy has left China with fewer young people to fill jobs and with a large ageing population. China does not need foreign investment; it needs money to pay for social security. That probably means higher taxes, and it is profitable companies most likely to be called upon.So how has the Russian invasion of Ukraine affected China? It has sided with Russia, but has to date avoided being dragged into the conflict. Doubtless, Beijing has observed the effectiveness of Western sanctions on Moscow and noted how much worse such sanctions would affect their own economy. Again, look at the trade data which highlight just how important a part of the global economy China is. It exported $2.7tn of goods in 2020, according the World Bank, and is the world’s biggest manufacturer of mobile phones, computers, office machinery and clothing. The US is by far its biggest market. Neither country wants a sudden cessation of trade.How much risk does investing in China have for investors on balance? A good acid test is to ask yourself: “If you bought a share and found that your shareholders’ rights were being abused, would you expect the local courts to uphold your rights?” You might also ask: “How likely is the stock exchange to close or the local currency to be sharply devalued in time of stress?”Very cautious investors will note that Russia closed its stock exchange as soon as the war started, effectively leaving western equity investments worthless. Some may recall many shares quoted on the Shanghai index being suspended for some weeks in 2018. The market had fallen sharply during trade disputes with the Trump administration in the US. Beijing currently seems to be trying to avoid a repeat of such a dispute. This is encouraging.Indeed, some investors may be tempted by the very low valuations of Chinese companies. According to Bloomberg data, the Shanghai stock market trades on 15x this year’s earnings and Hong Kong 8x. The US stock market trades on 23x on the same basis. China’s economy is very likely to grow faster than that of the US over the next 20 years, probably with less inflation risk. So, in some eyes, current Chinese valuations offer an attractive “entry point”; and that may well be right.

As a global equity manager, I have a wider range of options than managers specialising in specific regions or sectors. Though it is an important economy, I can dip out of China. Other markets in the region can give me exposure to the higher growth rates expected in Asia while allowing me to spread my holdings between different political environments. The South Korea Kospi index trades on 12x earnings and Taiwan on 14x earnings.A few years ago the funds I run had 10 per cent of assets in China. Today we have a similar amount in South Korea and Taiwan, including Samsung and Taiwan Semiconductor, which are the largest stocks in each index.We also have wider exposure to emerging markets through holdings in developed countries. Take, for example, Singapore Telecom, which has a controlling stake in the biggest mobile phone operators in Indonesia and Malaysia. This is a good illustration of the businesses we particularly like — resilient companies operating in “cockroach” industries from what we consider to be safe domiciles. Investors cannot avoid risk, but often there are ways to help mitigate it.Simon Edelsten is co-manager of the Mid Wynd International Investment Trust and the Artemis Global Select Fund More

Investors in China equity exchange traded funds have needed nerves of steel in recent weeks. Spooked by the war in Ukraine, anxiety over regulatory crackdowns and Chinese Covid outbreaks, they were in no mood for more bad news.So on March 10, when the US Securities and Exchange Commission named five Chinese companies listed in New York as the first of as many as 270 that face delisting if they do not supply audit documents, investors took fright.The $6.5bn KraneShares CSI China Internet ETF (KWEB) lost around 10 per cent of its value on each of the following three days. Then on March 16, a speech by Chinese vice premier Liu He, promising to introduce “policies that are favourable to the market”, brought money flooding back and KWEB reacted by shooting up 40 per cent in one day.Investors in the $760mn EMQQ The Emerging Markets Internet & Ecommerce ETF, which has a 51.6 per cent exposure to China, also experienced a bruising ride — at one point falling to just a third of the all-time high it hit in February last year.“It might have been the darkest day in my professional life,” said Kevin Carter, founder and chief investment officer of EMQQ. Like KWEB, EMQQ also enjoyed a bounce, gaining more than 24 per cent in one day after Liu’s speech. But the gains each ETF made have not been enough to repair all the damage suffered over the past year and investors have also had to weather fears of an economic slowdown caused by harsh new Covid lockdowns across China, including in the huge cities of Shanghai and Shenzhen.EMQQ, for example, had $1.9bn in assets under management at the end of February 2021. That figure had sunk to $811mn at the end of February 2022 and was at $731mn on March 28. Carter insisted that the fundamental idea of investing in emerging market internet and ecommerce companies in the developing world including China remained unassailable. He said the aggregate revenue growth of the companies EMQQ invested in was 35 per cent in 2021 and thought it should be a robust 20 per cent for 2022.The problem as Xiaolin Chen, head of international at KraneShares, pointed out, is that investors are not interested at the moment in the fundamentals of what is happening in China and have instead become fixated on the macro picture.Analysts at JPMorgan are in agreement. In a report on China internet investing issued at the height of the mid-March China rout the analysts said the potential delisting of Chinese companies’ American depository receipts was a catalyst, rather than a root cause, of the decline in sentiment.“We believe the SEC announcement has triggered investors to reassess China’s geopolitical risks, which has led to significant fund outflows from the internet sector as global investors rebalance their global capital allocation,” the analysts wrote.Rather than “doubling down” and loading up on Chinese internet companies at cheaper valuations, JPMorgan said that while it believed that over the long term stock prices would be driven by fundamentals, “we recommend investors avoid China Internet on a 6-12 month view.”Both KWEB and EMQQ are focused on tech and internet-related investments that have been particularly badly affected by China’s sweeping regulatory crackdown on the technology sector. In addition, all their Chinese holdings are in overseas-listed securities.“The fallout from all of this has been worst for what I refer to as ‘offshore’ China — ADRs trading in the US and shares of Chinese companies listed in Hong Kong — because the mega-cap consumer tech companies that are in the crosshairs of China’s regulatory crackdown are mostly listed offshore, and Chinese ADRs face the additional threat of being delisted by US regulators,” said Phillip Wool, managing director of Rayliant Global Advisors, whose Rayliant Quantamental China Equity ETF (RAYC) invests only in onshore-listed China A-shares.He said around $9.2bn had flowed out of Chinese stocks through the Stock Connect programme, which allows offshore investors to buy mainland shares, in the four weeks to March 28. That compared with an average net monthly inflow over the previous 12 months of $4.8bn.The question for all offshore China investors is whether investors should simply avoid Chinese equity ETFs, at least in the short term. Carter said that on a fundamental basis “the story hasn’t changed much at all”. Ecommerce and internet penetration in the developing world, he pointed out, is still much lower than in developed nations. Meanwhile in 2021, for the first time in EMQQ’s history, the number of non-Chinese companies surpassed the number of Chinese ones. “That trend will likely continue,” he said.Wool cautioned that there were “value traps” — companies whose fundamentals are genuinely impaired by shifts in policy, or by macroeconomic and geopolitical challenges.But he argued there were now bargains to be found especially in fast-growing companies in “boring” industries like industrials or materials and high-quality state-owned enterprises that stand to benefit from China’s push for “common prosperity”. However, Brendan Ahern, chief investment officer at KraneShares, said that despite the early optimism following Liu’s speech, it looked as though an early resolution of the problems thrown up by the audit document requirement was unlikely.“What got us here is what will get us out of here: regulatory policies,” said Chen. More

Costas Milas is a professor of finance at the University of Liverpool. In this post, he explains why a series of sharp rate hikes in the UK will do more harm than good. For the first time in almost 15 years, there’s a chance the Bank of England’s main policy rate ends 2022 higher than their inflation goal. Markets expect the Bank’s Monetary Policy Committee to raise the rate to almost 2 per cent by the end of this year. If that happens, it would mean rates soaring by a whopping 125 basis points over the next nine months. But will benchmark borrowing costs rise by as much as policymakers and financial markets think?Monetary bureaucrats are certainly talking tough. But tough talk is not necessarily going to be followed by strong action. Residents of Threadneedle Street, aghast at the latest inflation readings but fearful that tighter monetary policy may weigh on growth, could well be praying that jawboning alone is enough. Expectations of higher interest rates can indeed lower inflation in and of themselves, by pushing the domestic exchange rate up and reducing the cost of imports. But the effect is likely to be modest. The sterling effective exchange rate (which considers movements in the pound against Britain’s main trading partners) has appreciated by 0.93 per cent since the Bank of England started tightening policy in December 2021. About 20 per cent to 30 per cent of exchange rate movements eventually (over three to five years, that is) pass through to the UK Consumer Price Index. So, in theory at least, we should see CPI fall by between 0.19 per cent and 0.28 per cent. That’s hardly enough to temper a cost of living crisis that governor Andrew Bailey described as “historic”. Talk is cheap. The impact is small. You get what you pay for. Yet the question remains: would substantial and speedy increases in interest rates, potentially more costly in terms of their impact on growth and financial stability, be worth the price? In short: no.To explain why we need to look at the so-called output gap – a measure of excess demand – and potential supply in the economy. When output is above potential and there is excess demand, inflation should rise. When output moves below potential, there is downward pressure on prices as supply swamps the system.Central banks use the output gap to form a judgement on whether their actions can push inflation back to their 2 per cent targets. And, after the tremendous fiscal and monetary stimulus unleashed in the UK to counter the impact of the pandemic, it would be fair to assume that demand is now in “excess”. At the same time, however, the output gap is very sensitive to headwinds. Among them, uncertainty. Uncertainty harms economic growth because business delay their investment decisions and consumers become less likely to spend. That weighs on both supply and demand, but the impact on demand is more immediate – and so of more concern to policymakers now mulling a series of rate hikes. The chart below maps the impact of this uncertainty. It shows the output gap, as measured by the UK’s Office for Budgetary Responsibility together with an aggregate index of uncertainty that I have constructed by pooling information from four measures. The first monitors how many UK newspaper articles contain various relevant terms such as “uncertainty”, “economic” and “deficit”. The second is a measure of financial stress, which looks at volatility in the pound and in the UK stock and bond markets. The third – a measure monitoring stock-market volatility based on pandemic disease developments. The fourth – a gauge of global geopolitical risk.

Let’s look back over the recent past. Uncertainty rose significantly at four points: the 9/11 terrorist attacks of 2001, the 2007 to 2009 global financial crisis, the UK’s decision to leave the EU in 2016, and the early stages of the pandemic in 2020. In all of these periods but Brexit, that uncertainty subsequently widened the output gap between actual demand and potential supply. The measure is ticking up again following the outbreak of war in Ukraine. Research by my colleagues and I at Liverpool University supports the conclusions that can be drawn from the chart, finding that a rise in uncertainty depresses UK economic activity for up to 20 months. Output gaps are often rubbished. The gap between current demand and potential supply is notoriously tricky to measure. And it would be unwise for monetary policymakers to base decisions on how big, or small, the OBR – or any other body – judges the gap to be. Former MPC member Kristin Forbes and colleagues have also warned that the inflationary impact of positive output gaps, like the one currently estimated by the OBR, is stronger that the equivalent deflationary impact of negative output gaps. Inflation is more than three times the Bank’s target – and is set to rise further in the coming months. All of those factors make us cautious in ascribing too much power to any one measure of the economic outlook. Yet in light of Russia’s brutal invasion of Ukraine, it’s reasonable to assume rising uncertainty will cause a big drop in the UK’s positive output gap over the coming months, opening the door for a swift reversal of inflationary pressures. That ought to provide officials keen for a series of sharp hikes with some food for thought. The Bank’s policymakers are facing one of the toughest challenges since they were granted independence a quarter of a century ago. As Greek scientist Thales of Miletus famously noted that “the past is certain, the future obscure”. At few points over recent decades has that statement felt as true as it does today. Yet the MPC must act on the basis that they have a reasonable idea of what might come next. Monitoring movements in measures of uncertainty will not provide policymakers with crystal ball, but it may make the outlook for the UK economy a little clearer. More

The unprecedented financial sanctions imposed on Russia after its invasion of Ukraine threaten to gradually dilute the dominance of the US dollar and result in a more fragmented international monetary system, a top official at the IMF has warned.Gita Gopinath, the IMF’s first deputy managing director, said the sweeping measures imposed by western countries following Russia’s invasion, including restrictions on its central bank, could encourage the emergence of small currency blocs based on trade between separate groups of countries.“The dollar would remain the major global currency even in that landscape but fragmentation at a smaller level is certainly quite possible,” she said in an interview with the Financial Times. “We are already seeing that with some countries renegotiating the currency in which they get paid for trade.”Russia has sought for years to reduce its dependence on the dollar, a campaign that accelerated in earnest after the US imposed sanctions in retaliation to its annexation of Crimea in 2014. Despite those efforts, Russia still had roughly a fifth of its foreign reserves in dollar-denominated assets just before the invasion, with a notable chunk held overseas in Germany, France, the UK and Japan. Those countries have now banded together to isolate Moscow from the global financial system.Gopinath said the greater use of other currencies in global trade would lead to further diversification of the reserve assets held by national central banks.“Countries tend to accumulate reserves in the currencies with which they trade with the rest of the world, and in which they borrow from the rest of the world, so you might see some slow-moving trends towards other currencies playing a bigger role [in reserve assets],” she said. The dominance of the dollar — backed by strong and highly credible institutions, deep markets and the fact that it is freely convertible — was unlikely to be challenged in the medium term, she added.

Gopinath noted that the dollar’s share of international reserves had fallen from 70 per cent to 60 per cent over the past two decades, with the emergence of other trading currencies, led by the Australian dollar. About a quarter of the decline in the dollar’s share can be accounted for by greater use of the Chinese renminbi. But less than 3 per cent of global central bank reserves are denominated in Beijing’s currency, IMF data show.Beijing was in the process of internationalising the renminbi before the current crisis and was already ahead of other nations in adopting a central bank digital currency, said Gopinath. But she added that the renminbi was unlikely to replace the dollar as the dominant reserve currency.“That would require having full convertibility of the currency, having open capital markets and the institutions that can back [them]. That is the slow-moving process that takes time, and the dollar’s dominance will stay for a while,” she said. The war would also spur the adoption of digital finance, from cryptocurrencies to stablecoins and central bank digital currencies, she added. “All of these will get even greater attention following the recent episodes, which draws us to the question of international regulation,” said Gopinath. “There is a gap to be filled there.” More

The last time western sanctions hit Russia after it annexed Crimea, President Vladimir Putin turned to Huawei to rebuild and upgrade the territory’s communication infrastructure. Now the controversial Chinese technology company is positioned to aid the Putin regime on a much larger scale, despite the threat of Washington hitting it with more sanctions.In Crimea, Russia “ripped out western telecom gear in the heavily militarised territory and replaced it with Huawei and ZTE”, said Hosuk Lee-Makiyama, a telecoms expert at the European Centre for International Political Economy. If Nokia and Ericsson do fully exit Russia, Moscow would “need Chinese companies more than ever, especially Huawei”, he said.Despite an initial plunge in phone shipments, Huawei has been an early winner from the Ukraine war. Its phone sales in Russia rose 300 per cent in the first two weeks of March, while other Chinese brands Oppo and Vivo also recorded triple-digit sales increases, according to analysts at MTS, Russia’s largest mobile operator.Its four Russian research centres are recruiting dozens of engineers, including machine learning scientists in Novosibirsk, speech recognition researchers in St Petersburg and big data analysts in Nizhny Novgorod. Huawei has also added new sales and business development openings in Moscow since the invasion of Ukraine began, according to its website. But experts say Chinese tech companies such as Huawei and rival Xiaomi risk violating sanctions if they keep shipping phones and telecoms gear to Russia. They need sign-off from Washington because the electronics often contain high-end semiconductors or are made with US tools, making them subject to new sanctions on Moscow.

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Huawei could be hit with more sanctions from Washington — such as Trump’s order to ban ZTE from accessing any technology connected to the US — that would deliver another big blow to the Chinese company’s operations. “My bet would be it’s impossible for [Huawei and other Chinese phonemakers] to export legally to Russia,” said Kevin Wolf, a former commerce department official and sanctions expert. “It is theoretically possible that [Huawei] has been able to figure out how to make a cell or base station without US tools, software etc. But it’s hard to believe they would be able to find all the [semiconductors] that were not made with US tools.”Huawei has been working to wean itself off the US semiconductor supply chain since American sanctions introduced by the Trump administration cut its access to chips. Guo Ping, the company’s rotating chair, told reporters on Monday it was relying on a stockpile of chips. He added that Huawei was working to redesign products to bypass the US supply chain by getting equivalent performance out of less advanced chips.The sanctions have been most damaging to Huawei’s chip-heavy smartphone business, causing its consumer product revenue to shrink 50 per cent last year, the company said on Monday. Huawei’s total revenue last year fell 29 per cent year on year to Rmb636.8bn ($100bn), buoyed by roughly flat sales in its telecoms and enterprise business lines.Huawei’s heir apparent Meng Wanzhou, who recently returned to China after almost three years of detention in Canada over alleged breaches of sanctions against Iran, said Huawei teams “have been under a lot of pressure over the past few years”.“This has made us more united and has made our strategy more clear,” she said.

Russia needs Huawei. Apple and Samsung’s retreat has put half the smartphone market up for grabs, while Ericsson and Nokia’s suspension of their Russia business has left a hole in the supply of telecoms equipment for broadband and mobile network infrastructure that will need to be maintained and eventually upgraded. Russia was Huawei’s first foray into foreign markets more than two decades ago and sanctions have deepened the relationship, with Huawei finding a willing buyer of network infrastructure that is increasingly shunned in western capitals and a deep pool of engineering talent. As with Crimea, when Russia needed a dependable company to supply the hardware backbone of a new sanction-proof national payment system, called Mir, it turned to Huawei.Huawei had already won a significant portion of the contracts to roll out 4G and 5G networks in Russia, said analysts. Huawei and Chinese peer ZTE control roughly 40 to 60 per cent of the market for wireless network equipment in Russia, according to market research company Dell’Oro, with Nokia and Ericsson making up most of the rest.Opportunities for Huawei may also lie in sharing its sanction-proofing projects with Russia, including the Harmony operating system developed for its phones after losing access to Google Mobile Services.Vladimir Puzanov, chief executive of Russian phonemaker BQ, last week told Russian media that the company was looking at installing HarmonyOS on new devices. Huawei said it did not have plans at present to “launch or to promote HarmonyOS outside China”.

Video: China, Russia and the war in Ukraine

“Huawei has a huge share of the Russian market . . . and right now the current sanctions are already like a 200-pound weight on their head, so what’s scary about another 20 pounds?” said Yang Guang, a Beijing-based analyst at tech consultancy Strategy Analytics. “Still, as a commercial organisation, they will probably wait and see for the time being.” Washington is watching Huawei closely. Matthew Borman, an export official at the US Department of Commerce, on Tuesday threatened Chinese companies bypassing Russia sanctions with a “complete prohibition [of] not only trade but any transaction” or even “a denial order . . . like the one we imposed on ZTE”.Borman said Washington had granted a significant number of export licences for foreign suppliers to keep selling to Huawei, but that those could be revoked. Huawei’s Guo said the company was “carefully evaluating” the new sanctions. Huawei declined to answer further questions about its plans in Russia.Nian Liu contributed reporting from Anhui More