By Jim O’Neill, Chairman, Goldman Sachs Asset Management (this week’s ‘Viewpoints’).
My last week was especially exhausting as there was so much going on and I had to organise so many things. And I wasn’t even travelling! Just trying to keep up with the huge array of things going on everywhere was tough enough, never mind the madness that is known as Europe, which unfortunately once more will be my underlying theme this week.
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A growing number of readers are asking me about the future of the Viewpoints and life going forward. Well, you will have another three or four to suffer before I disappear at the end of April, and then you might get more sensible information and ideas from my GSAM colleagues in the Office of the Chairman in their revamped life once they have disposed of me. After April, I am looking forward to pondering life a little and as much as I enjoy writing these, I won’t have quite the same access to all my sources and certainly wouldn’t find the idea of maintaining a mailing list a great deal of fun, never mind those weekend personal computer glitches. I suppose there might be the occasional “Viewpoints from the Beach (or Frozen Rainhut)”, you never know. And beyond spring and summer, we will have to wait and see what the autumn brings in.
The BRICS Bank and Other BRIC Bits.
The BRICS leaders have announced their agreement to set up a joint Development Bank although they avoided the tricky stuff, such as where it would be located, how much capital and who would contribute what. This is exactly what Amrita Narlikar of the Centre for Rising Powers at the University of Cambridge suggested to me a couple of weeks beforehand, so I shall be quizzing her as to what happens next. Stefan Wagstyl wrote an excellent summary about it all in the Financial Times on Thursday 28th March. It would seem to me that all the big decisions are for China to make, given they are the same size as the rest of them put together. I shall be watching this closely. If China takes the lead initiative in filling the important details, as they probably should, this would be the beginning of them showing concrete signs of taking their global responsibilities in governance and economic leadership more clearly. It is all quite exciting for them and those of us who have been there since the start of the BRICs journey.
There were a lot of other interesting things about the BRICS last week.
It was most interesting that President Xi visited Moscow en route to Durban, choosing Russia as his first formal overseas trip. I have not read this myself but a couple of people claim that at their joint press conference they each said that the other was their most important partner. I can see why Russia might say that – it is increasingly the case for all of us (although so many still don’t realise) – but for the Chinese to say that about Russia, then if true, that is quite a statement.
Another interesting thing I noticed was that the FT reported in its 23rd/24th March weekend edition that Lord Nat Wei had proposed the idea that UK local authorities should create BRICS “units” in which they sell their expertise to large emerging nations and forge closer trade links. Good idea, Nat, not least because I have been suggesting exactly just that to a certain north-west English city that is known to some of us as the Centre of the Universe.
Sticking with Russia, I also saw an interesting story that some Russian and Ukrainian football club owners are talking about developing a joint league to take over from their domestic leagues to boost standards as well as, no doubt, commercial opportunities. I haven’t had the opportunity to discuss this with our resident Ukrainian, Miss BRIC herself (well, Miss for another week), Anna Stupnytska. I suspect she might not approve but I think it is a cool idea.
China.
Away from the summit and their Russia visit, there were lots of other interesting things about China last week, as usual. It was yet another pretty miserable week for owners of China A shares, especially Thursday, when the regulatory authorities announced a clampdown on so-called Wealth Management Products (WMP) offered by the banks and with it, presumably, the much discussed shadow banking activities. GSAM’s Jason Granet suggested to me that this policy decision was a good thing as he had thought that, left untouched, this might be the thing that could really go wrong for Chinese economic policy. To his credit, he has been saying that to me for some time, so I hope he is right. The equity market seems to have seen it differently, and one might say that the local market seems to see everything negatively these days, and it ends March, now negative for the year. With respect to this latest development, I find myself thinking the following slightly odd thought: Are the policymakers clamping down on too many things at the same time? First exports (indirectly of course, but by boosting wages and allowing continued RMB appreciation), then property curbs, recently luxury and lavish gifting, and now this?
China’s final PMI for March rose to 50.9, up from 50.1 last month, but softer than expected.
I have followed a Chinese Financial Conditions Index (FCI) for years as a leading indicator and it has been very useful for me in helping to guide my relative views of the Chinese cycle. (Please find the chart attached.) Despite all my China structural bullishness, its tightening from 2009 to 2011 and its subsequent lack of major easing is why at GSAM we have had a more cautious view of the cycle than the consensus for the past two years. Many people have suggested to me that the proliferation of the shadow banking system was why it didn’t matter. I never fully believed this, and now with this clampdown, unless they ease financial conditions, I suspect that the Chinese cycle will be softer than consensus forecasts for 2013 at least. So, contrary to market expectations, could we end up with an easing of policy?
The San Francisco Fed published a short research piece looking at the accuracy of Chinese GDP data and claimed that, surprise surprise, it is accurate as it correlates with virtually all other evidence. My response to a number of people who emailed this piece to me was that I look forward to when the SF Fed undertake a similar study about the accuracy of UK GDP data. I have studied this topic many times and I think those who persist in thinking that the Chinese deliberately manipulate their economic data simply reveal a huge bias in their judgement. Ironically, the next email in my inbox to one of those concerning the SF Fed report was one about the latest upward revisions to UK GDP data, which is almost as reliable as night following day. It really is about time the UK Office for National Statistics do something about this seemingly reoccurring systematic bias. After their next revision, it is quite possible that the much discussed “double dip”, which seemed dubious for many of us at the time, actually didn’t happen.
For some reason, I found myself re-reading two research notes from 2011 from the Shanghai Development Research Foundation about the RMB and the Special Drawing Rights (SDR) this past week. It reminded me that a number of Chinese thinkers seem to believe there is a chance that the RMB might be part of the SDR basket by 2015, as it clearly should be based on China’s GDP and role in world trade, if the International Monetary Fund were more imaginative about helping a move towards a more balanced global governance system. One of the papers intriguingly suggests that all major currencies other than the USD should peg their currencies to the SDR, which right now would appear to be an amusing challenge, given that most SDR currency constituents are under guidance to decline. But it got me wondering whether the People’s Bank of China actually watch the RMB/SDR rate closely? I got James Wrisdale to create the attached charts for the RMB over different times. As you can see, what stands out most is how undervalued the RMB seemed in the 1990s but the gap has gone.
The N-11.
I had the pleasure of meeting a young Iranian woman last week and amongst other things she said to me that I don’t write enough about the N-11 or Iran. So here you go, job done! Meeting her reminded me somewhat of my days during my PhD research when I shared an office with an Iranian guy during the revolution, and how bright he and many of his friends were, as well as their constant munching on pistachios. At one point in the future we might be able to really include Iran in our N-11 and not keep it just an N-10, and as I have occasionally pointed out, Iran scores higher than a number of others on the GS Growth Environment Score (GES) list of sustainable growth and productivity. Mind you, I also spoke to a well-known CEO last week who told me of an event he had recently attended where US intelligence officials said they were becoming resigned to a trickier relationship with Iran over nuclear matters, so it might be some time…
Funnily enough, I had already intended to briefly mention the N-11 countries as inflows to the N-11 markets continue to be very strong and, probably related to it, a number of them continue to show evidence of a brighter life.
Katie Koch sent me an interesting note suggesting that Nigerians were becoming huge consumers of the bubbly stuff, with an FT piece citing a report that over the next five years their consumption will be the second largest after the French, and apparently comfortably ahead of ourselves here in the UK.
David Pilling wrote a very interesting piece about Indonesia in the FT last week focusing on the next election, arguing that the country doesn’t need a strong leader in the traditional Indonesian sense and that it would be better for the sustainability of their story if the link between business and running the country were further reduced. It is tough to argue with that.
Staying in that part of the N-11 world, the Philippines were upgraded last week to investment grade by Fitch and it is probably a matter of time until the others follow suit.
This occurred on the same day the FT carried an article about the rapidly shrinking stock of AAA-rated sovereign paper, as well as an even more interesting piece focusing on the dilemmas of everyone chasing so-called emerging market bonds. Some statistics were cited, including that the outstanding stock of all emerging market bonds is “only” $4.9trn, and if investors did what many recommend (ourselves at GSAM included), then the new issuance for the next three years would be gobbled up easily. I guess if Europe carries on behaving how it has in the past fortnight, it might take place in even less than two years!
The Madness Known as the UK?
Beyond the UK GDP revisions, last week saw some more interesting developments, one of them the announcement of three new members of the Bank of England’s Financial Policy Committee (FPC). I wonder whether these guys will try to shift the balance about the seemingly never-ending demand for UK major banks to raise more capital, as it is tough to marry this with the other seemingly never-ending, and probably more necessary, demand for the same banks to be lending more.
Another great piece in the FT last week was written by Chris Giles, talking about “Plog”, in which he highlighted the clear oddity of the Office for Budget Responsibility (OBR) economic forecasts that appear to now predict a constant underperformance of the economy relative to its trend, so that the economy is never back to normal but the growth trend itself is not that weak. This is the sort of box their existence has put them into under the apparent desire for transparency from our elected leaders. All a bit mad, if you ask me. People want some growth and a job, and getting endlessly wrapped up in questions such as what is the growth trend, where is it, what our thinking will be in the future, is all a bit over the top. The reality is that probably at some unpredictable time the economy will grow really sharply for a couple of years, so that the recovery to trend does eventually happen. But in this era of self doubt and endless miserable comment, it is close to impossible for anyone to think of suggesting such, not least because there doesn’t seem to be any initiative to create it. Or, at least, not from anyone outside our forthcoming superhero Mark Carney. Of course, the economy’s trend really could have collapsed, but I still find that quite hard to believe.
David Miliband caused a bit of a surprise this week, announcing that he was off to the US to take an important charitable job, apparently abandoning our political scene, at least for now. I am amongst those that are disappointed as he is someone who, I think, if not understands our complex world completely, has a better crack at it than most of us. Mind you, following the weekend’s results and the also seemingly mad replacement of Martin O’Neill with Paolo di Canio as Sunderland manager, it wouldn’t be that surprising if the rest of Sunderland’s fans went with him.
I am not sure if they have started off a new round of activism for the non-coalition political parties, but Labour appears to be agitating for clearer economic stance, and over the weekend, the apparently rising popular UKIP has announced a plan for a flat rate 25% income tax. Quite what this might do for the fiscal arithmetic would be interesting, but I suspect it might attract more support in the polls and cause the Tories fresh angst.
Anyhow, the most interesting thing I came across this week about the UK came from my brother in law in the States who forwarded most of the family members a highly amusing email about a new business line in “professional sobbing” in his native Essex, in which supposedly people are paid to turn up to under-attended funerals to sob endlessly. Perhaps another area we can explore exports?
The Madness Known as the US?
Compared to much of the rest of the West, is the US looking that mad? Their own politics often seem quite mad but perhaps it just stays inside the beltway. It certainly doesn’t look that bad, indeed, I see that my old colleagues in GS Economics have raised their tracking estimate for Q1 real GDP to 3.4%. This follows a robust consumer report for February, which along with other evidence suggests the housing market’s strength is having a broadening positive impact. Mind you, the Institute for Supply Management (ISM) release disappointed somewhat yesterday, dropping to a softer than expected 51.3, quite a bit below consensus, and some of the components were soft, too, suggesting the momentum going into Q2 isn’t as strong.
The Madness Known as Japan?
Expectations for new BoJ Governor Kuroda continue to mount, not least because he keeps implying that he is going to lead them into the promised land, and do special things to ensure that inflation will be on a path towards 2%, and, of course, his boss Mr. Abe is demanding the promised land. The latest economic numbers in Japan are mixed, with disappointing industrial production but consumption and confidence indicators looking ok. It is interesting that the domestic bond market is suddenly more sensitive to impending BoJ moves, and less so the FX market. On one level, the FX market has travelled so far, it is hard to keep travelling. So, I am not sure how you get further Yen weakness without something big. I have a suspicion that it will eventually be from the US side and not from inside Japan, but we shall see. I wouldn’t be surprised if this recent modest correction goes further.
The Madness Known as Europe. No Question Mark Here!
Absolutely no doubts about madness in Europe the past fortnight. It is difficult to know where to start or how to really give it justice. But let me try and highlight a few bits:
1. Cyprus. So, a deal was put together that was not quite as insane as the original one. All domestic Cypriot citizens are not now being hit with a charge on their bank deposits, although the wealthiest are getting hit really hard. Chris Pissarides, Nobel prize winner and a good bloke to boot, wrote a brilliant comment in the FT on Friday in which he highlighted the apparent disproportionality of it as well as the remarkable contradictions.
2. As he and so many others have touched on, where do capital controls sit within the rules of Euro engagement? And indeed, actually within EU rules?
3. In a narrow technical sense, therefore we now have more than one Euro. I am sure if you went to Cyprus and tried to swap Cypriot Euro deposits with cash Euros from outside the country, the implied exchange rate would be pretty interesting.
4. Ironically, in the middle of this madness, I received an invitation to attend an EU conference and be part of a panel discussion on Banking Union. How does that work again?
5. Especially now, we worry that the Cypriot settlement might be a blueprint for others needing fresh support. New Euro group head Dijsselbloem was someone few of us have heard about until his interesting comments which, of course, he then rushed to deny. But what is one to think? I lose count of the number of discussions I had with people last week about possible flight capital from peripheral European banks again.
6. Who is next? Slovenia? Luxembourg? Would the same solution be applied to Luxembourg that has a very large banking centre compared to GDP and that some of its wealthiest depositors might be from the core?
7. Despite all of this madness, Latvia is making strong noises about joining the Euro next year…
8. The Netherlands is now making more noises about resisting further austerity policies, according to Monday’s FT.
9. In the context of Europe’s madness, the head of GSAM’s European bond portfolio team, Jon Bayliss, was the first amongst many to highlight a new business line in Spain: “My Mattress Safe” (check it out on www.cajamicolchon.com) shows what locals are thinking about what to do with their cash. Highly amusing.
10. Italy continues to find it impossible to get a government and the Five Star Movement still seem to be avoiding joining a coalition. And there is still a slight chance Berlusconi comes back.
11. French Prime Minister Hollande, irritated by the court ruling against the introduction of a special two-year 75% income tax on high earners, appears to have now proposed that their employees pay it instead for such high earners. Quite remarkable. Interestingly, at a dinner I was invited to with some leading UK business figures last week, in between expressing collective horror about the Cypriot events and the implications, the debate switched to the French economy, and a small consensus thought financial market types were being far too gloomy about France and felt their underlying industrial structure was better placed to cope with the challenges of the world than others, such as the UK. Not sure I would entirely agree with this, but it was a very interesting discussion.
12. The final and perhaps the most mad issue of the moment is the proposed Financial Transactions Tax (FTT). I am at a loss to understand how this proposal hasn’t been completely blocked by the more rational voices in Europe, and I also can’t understand why the UK isn’t a lot more noisy about this policy, which if implemented, would be quite damaging for London’s role as an international financial centre. Why exactly is it so clear for the UK to want to remain in the EU if they can’t influence anything? I attach a brief article from Deutsche Bank’s Chief Economist, David Folkerts-Landau, which shows just how damaging it would be. Absolute madness.
The Madness Known as Economics and Markets. Our Monthly Gives You a Method.
At the start of last week, I had the pleasure of being invited to the London School of Economics all-star cast for the beginning of BoE Governor Mervyn King’s leaving celebrations. There was a 90-minute panel presentation and discussion about what economists and policymakers could learn from the crisis. Messrs Bernanke, Blanchard, Summers and Weber joined King for their 15-minute views and further discussion.
A few takeaways from it for me: Firstly, as Larry Summers pointed out, central bankers are undertaking policies that they have not really been trained to be specialists in, and today’s times along with the 1930s have been when central bank policymaking has been most important and yet their training is not really of its designated use. He also controversially suggested that standard assumptions of macro policymaking being to reduce volatility around some trend of growth might actually have been wrong.
Secondly, following Weber’s comments in which he thought the longer-term consequences of giving central bankers all these powers might be quite dangerous, and amusingly pointed out that the way things are going, one part of a central bank will be perhaps blaming and having to compensate for the possible mistakes of another part of the same institution at some point in the future.
The others didn’t quite see it the same way, although the fact that macro regulation was a new addition to the policy tool box was mentioned by all.
Bernanke focused most of his prepared comments, trashing the currency wars arguments, while Blanchard spent much of his time on the new macro prudential theme.
The third takeaway for me was that there continues to be a clear difference between the US view of appropriate policy activism from that in Europe, and it is striking how the events from 2007 to 2013 have not narrowed these differences one little bit.
So, do we know anything about the right economic policies or, indeed, economics? At least, it was a fun dinner for some of us afterwards.
In the midst of all this various madness, we published our March “Monthly Insights”, entitled “A Simple Alternative Asset Allocation Framework”. In it, we showed that over the past 40 years, an approach using the following indicators; equity risk premium, real interest rates, momentum and a cyclical leading indicator, to allocate between cash, bonds, equities and gold (we use a basket of real assets in one version instead of just gold), you could have achieved an average annual return of 13.2% with quite low volatility. And yet, we all claim because of the madness that persists, it is really hard. There is method in the madness.
8 games to go, and 15 points clear! Come on you Reds.
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