By Bilal Hafeez 11-07-2019
In: post | Newsletter

Macro Hive Weekly Brief: Deutsche’s Real Problem / Big Tech Fraud / Fed’s False Target

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(total reading time: 9 mins)

Having worked at Deutsche Bank for many years, I’m always tuned in to stories on it. And this week has been replete with them. Many focus on the announcement of dramatic staff cuts or the bank’s potential involvement in the scandal-hit 1MDB investment fund. But in a special report, I write that the real story is Deutsche’s balance sheet challenges.

Although big banks have been under fire since the 2008 financial crisis, it seems Big Tech is now in the firing line. Politicians are attempting to use anti-trust laws to disrupt the likes of Facebook and Google. But in today’s Macro Hive Brief, John Tierney, a veteran macro strategist, finds that this approach may be futile. Instead, he argues that the prevalence of fraudulent products and services on these platforms could be the true Achilles heel of Big Tech.

In his testimony to US congress yesterday, Fed chair Powell stated that ‘inflation has been running below [our] symmetric 2% objective’, and ‘there is a risk that weak inflation will be even more persistent than we currently anticipate’. He may therefore be interested in our special report on US inflation. It finds that over the past few hundred years, US inflation has averaged less than 1%, so history could be working against the Fed’s two percent inflation target. This suggests looser monetary policy for longer, which equity markets will love.

Elsewhere in our round-up of blogs, we have one analysis showing the positive economic impacts of Trump’s deregulation drive and another analysis showing the ineffectiveness of his policies to de-globalise US companies. On politics, there’s a study that finds voters are basing their decisions on perceptions of the economy rather than its actual performance. And on China, there’s an excellent investigation that finds Huawei employees hold numerous connections with China’s state secret service.

Finally, if you ever felt like leaving the rat race and going to live off-grid, then check out my latest personal blog: No Place Like Utopia. It looks at one man’s attempt to do just that. And it didn’t end well.

That’s all for now.

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The Real Meaning of Deutsche Bank’s Decline (4 min read) Deutsche Bank is back with another major overhaul – this time, exiting equities and slashing staff numbers. While some of the poor performance is due to bad management, much is to with Europe’s low interest environment. But the real issue could be investors poor valuations of Deutsche’s assets. This suggests there could be an underlying market liquidity issue, which is preventing the  bank from offloading these assets. And this is likely a broader financial sector issue, not just Deutsche’s. (July 10 │Bilal Hafeez)

Big Tech Fraud Alert (4 min read) Politicians are targeting Big Tech through anti-trust legislation, but this could turn out to be fruitless. The real challenge could be made through the level of fraudulent activity engaged on tech platforms from fake news to fake products to fake businesses. If tech companies don’t devote enough resources to clamp down on the problem, regulators could step in. Don’t hold your breath though – this kind of vital regulation is still merely a whisper. (June 29│John Tierney)

Should Central Banks Follow the Two-Century Inflation Target? (2 min read) Central banks having an inflation target of 2% tends to go unchallenged. However, since the 1800s, inflation has averaged just under 1%. There have been inflation shocks especially during war-time and oil price spikes, but otherwise inflation has tended to be benign. So what if the ‘true’ level of inflation is lower than the current targets? Central banks will end up constantly over-easing policy. (July 10 │Bilal Hafeez)


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For details: How Climate Change Will Impact The Biggest Economies

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Trump’s Deregulatory Successes (Defining Ideas, 5 min read) Out of the 35 members of the OECD, the US has the 9th most restrictive regulations on products and markets. The Council of Economic Affairs (CEA) recently published a report stating that Trump’s current deregulation efforts and his plans to regulate less in the future will have increased US real incomes by $3,100 per household over the next 5-10 years. The article also goes through the other positives of deregulatory efforts: lighter requirements of drug approvals by the FDA, bringing competition and driving drug prices down; and reversing the flat fee structure of internet providers like Netflix, allowing heavy users to pay less and reducing compliance burdens on small firms to keep them in business. Trump also deregulated payday loans, allowing for more freedom in the short term lending space.

Why does this matter? In recent years, there has been a divergence on regulation trends in major economies – Europe and China have increased regulation, while the US has reduced it. This has likely contributed to US economic outperformance. It has also been a hallmark of the Trump administration, meaning a Democrat victory at next year’s Presidential election could engender a reversal and therefore negatively impact growth and asset markets.

Mysteries of Monetary Policy (Project Syndicated, 3 min read) Paul Volcker, who was a chairman of the Fed in the ‘80s, as a believer in inflation control and under his watch fed rates rose to 22% in 1981 where they peaked. His strategy for low inflation worked, and has since remained the principle monetary policy tool: they have maintained an average inflation of 1.5% since 2010. Robert Barro, a Professor at Harvard, however, presents a curious puzzle in monetary policy impact today. Recent research demonstrates that Fed rate changes and QE see only a small and delayed response by inflation and yields. Data shows that a contractionary monetary shock raises yields on Treasuries but only over a 3-5 year horizon, peaking at 2 years with only a moderate inflation impact observed over the same delayed period. Data also shows a contradictory reaction in output growth prediction – a rate hike predicts output growth and vice versa. Barro warns that there is therefore a credible threat of extreme Fed responses if inflation was to swing sharply in either direction – simply because policy tools seem to have a subdued and slow impact otherwise.

Why does this matter? If central banks have to engage in more extreme monetary policy actions to generate inflation, we cannot rule out negative rates and wider asset purchase programmes (such as in equities) even by the Fed.

What is Fuelling the Global Revolt Against Democracy? (World Economic Forum, 3 min read) The analysis finds that dissatisfaction with democracy is not related to a nation’s overall level of wealth and development. Rather, it is correlated with economic outlooks – the greater the economic pessimism, the greater the level of dissatisfaction. The article also finds that perceived protection of civil liberties within a country is positively correlated with the level of satisfaction with democracy. However, there is interestingly no correlation between independent external judgements of a country’s level of civil liberty rights enforcement and the country’s level of satisfaction. For instance, Spain receives a top score for protection of civil liberty rights by Freedom House, yet only half of Spaniards feel like their country protects their rights to free speech. The overarching theme seems to be that perceptions of situations, rather than accredited assessments, are more closely linked to satisfaction with a country’s political state.

Why does this matter? If it’s perception, rather than reality of income inequality and growth that matters, then politicians adept at influencing perceptions – such as those populists who take to Twitter so infamously – will win out over policy wonks.

How Have Changing Sectoral Trends Affected GDP Growth? (Federal Reserve Bank of San Francisco, 5 min read) While trend GDP growth in the US averaged 3.3% from 1950 to 2016, it has dropped to 1.7% since the 2000s. This article explores whether specific sectors are to blame. The authors especially focus on spill-over effects and ask, if productivity falls in one sector, to what extent does that indirectly hinder other sectors too? They find three culprits: construction, which is the biggest negative contributor due to its extensive links with most production; nondurable goods; and professional services. Taken together, these account for about 60% of the total decline in trend growth.

Why does this matter? The centrality of construction for trend growth helps explain why the 2007-2008 housing and banking crisis has cast such a long shadow over growth. For the future, it is worth picking growth index measures apart and focusing on re-booting the correct sectors.  

The Trump Tax Reform, As Seen in the U.S. Balance of Payments Data (Council on Foreign Relations, 8 min read) The Trump tax reform was considered to be the formula that would allow the US to claim back trillions of dollars of trapped profits and make America a more manufacturing-competitive landscape. But this article incisively debunks these claims. US firms have very little incentive to return large offshore profits at the reduced 21% tax rate when they can simply continue to pay an offshore rate of 10.5% (the global minimum). Distribution of US profits has actually increased in concentration in the seven low-tax jurisdictions since. Another key method of evaluating the effectiveness of these reforms is to analyse the balance of trade in sectors where firms outsource their manufacturing and import their goods into the US. It’s evident here as well that these policies were highly ineffective – US imports of pharmaceutical products, in particular, surged substantially in 2018, largely from these low-tax jurisdictions (Ireland, Singapore, and Switzerland).

Why does this matter? Much like President Bush’s tax reforms in 2004, Trump’s reforms have failed to bring an enduring return of US corporate profits back to the US. This suggests that these attempts at re-shoring or de-globalisation have so far failed.


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Huawei Technologies’ Links to Chinese State Security Services, by Christopher Balding, Associate Professor at Fulbright University Vietnam (Working paper on SSRN, 15 min read) In this academic working paper, which is part of a series of investigations, Christopher Balding investigates concerns that Huawei’s employees are directly linked to the Chinese state security services, making use of a number of CVs that leaked last year. The findings uncover, worryingly, direct links between employees and the Chinese military and intelligence services. And in some cases, links to specific instances of hacking or industrial espionage conducted against Western firms. Another red flag is that the employees confirm the hypotheses and willingly provide evidence of fraudulent behaviour themselves.

Why does this matter? Huawei has been adamant of its independence from the Chinese state, but this scholarship brings significant doubt to that claim. The US Congress already is sceptical towards Huawei, so President Trump’s recent lenience towards Huawei could be short-lived. This is a downside risk to tech stocks.

China’s Loans to Rest of the World Worth US$5 Trillion (6% of Global Economy), New Study Reveals (SCMP, 4 min read) China has been lending a lot more in international markets than official numbers record. New estimates suggest that China’s lending to the rest of the world reached $5tn in 2018, a tenfold increase from the early 2000s. The loans are often issued from Chinese banks to Chinese contractors overseas, which are not captured by IMF data on national debt statistics. Much of the lending appears to favour crisis-hit emerging economies, such as Venezuela, Zimbabwe, and Iran. This could be in an attempt to exercise ‘debt-trap diplomacy’. Overall, emerging market countries owe $380bn to China, compared to only $246bn to the Paris club of 22 Western countries.

Why does this matter? China’s international influence through lending may be larger than initially thought. This will raise Western concerns around debt-trap diplomacy lending, but also limits Western efforts to sanction countries like Iran and Venezuela.

Ursula von der Leyen Nominated to Lead European Commission – But Will She Be Tougher on China? (SCMP, 4 min read) Beijing is concerned about the future Europe-China relationship after the surprise selection of von der Leyen to head the European Commission. She has clearly expressed a belief that China poses multiple threats to Europe and should be treated similarly to Russia. She also opposes the level of citizen surveillance and lack of freedom in China and believes the surveillance system will sooner or later collapse. China hopes that its close trade links with the EU continue to thrive, since they are its biggest trading partner.

Why does this matter? So far, Europe has questioned its trade links to China amid confliction over its anti-democratic tendencies, but maintained them nonetheless. A new EC leader with a more pessimistic view on China could tip the balance in favour of ideology over economy.

Revised Demographic Forecasts for China: Key Takeaways (The Economist Intelligence Unit, 5 min read) Using the most comprehensive, once-a-decade national census of Chinese population in combination with periodic mini-census studies, the Economist provides a neat update on demographic changes in China. After a relaxation of the birth policy to allow for a second child in 2016, there was a jump in fertility. But this was quickly exhausted and levels fell again in 2018. It is expected that the peak population is likely to be reached earlier than expected – in 2026, in fact, when the EIU predicts a population of 1.41bn. The population overall, similar to aggregate OECD levels, is aging and by 2030 almost 18% of the population will be over 65. There will be a drop in the labour force due to the lower working age population, meaning higher labour costs and a sharp need for increased productivity to maintain GDP levels.

Why does this matter? As well as facing domestic credit challenges, China now has to deal with a potentially falling working-age population, which will hit trend growth by lower immediate output. But also the population is ageing which will hit public finances. This is all happening faster than expected.

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