Is North Korea Another Cuba?

By Roy C. Smith

Last week’s 1-day US – North Korea summit ended with a joint statement promising "mutual confidence building" to "promote the denuclearization of the Korean Peninsula." President Trump and Supreme Leader Kim Jong Un also made commitments to build a "lasting a stable peace regime on the Korean Peninsula," to work toward denuclearization and to recover POW/MIA remains from the 1950s. Though the statement was vague, expectations soared that North Korea would stand down its nuclear weapons and the US would withdraw sanctions and assist in developing North Korea’s economy. 

Evan Osnos, a China expert for The New Yorker who visited North Korea recently, suggests the unexpected change of heart by Kim Jong Un to be the result of the increasing amounts of foreign information leaking into North Korea through social and other media that show how so very badly off the country is relative to its neighbors. After 70 years of a “socialist paradise,” North Korea’s GDP per capita, stagnant for years, is only $583 -- China’s is $8,123 and South Korea’s $27,538. By this measure, North Korea is the poorest country in the world by a significant amount. Knowing this to be so, Osnos says, makes Kim’s regime vulnerable to upheaval from within, despite its harsh rule with 200,000 political prisoners. So, after seven years as chief of state, maybe Kim figures it is better to use North Korea’s newly achieved nuclear deterrent to bargain for relief from sanctions to get some economic development before it’s too late. 

The event brings to mind another momentously staged announcement, one in December 2014, when the US and Cuba agreed to normalize relations. Raul Castro replaced his brother as Supreme Leader in 2006, and he knew very well that the Cuban economy was crumbling, it had run out of credit with other socialist nations, and its main benefactor, Venezuela, was on its last legs. Something had to be done, so Raul liberalized some things -- permitting sales of personal property and real estate and freeing up local markets to small time entrepreneurs. But the only way out, Raul also seemed to know, was to restore relations with the hated US, in the hope that economic fallout would be enough to get the economy out of the no-growth slump it was in. But this was a big step and carried many risks. Raul took five years to think about it before commencing pre-announcement negotiations.

I was in Cuba a couple of weeks after the 2014 announcement and there was no doubt that the excitement it generated was considerable. All the Cubans one could see were talking about how much better things would become when the US trade “blockade” was lifted and incoming foreign investment would create a new world of enhanced economic activity.  In March of 2016, the US embassy was reopened and President Obama visited to celebrate the event.

Since then, not much else has happened on the normalization front. GDP growth shot up to 4.4% in 2015, because of a spike in tourism and increased expectations. But nothing else was reformed in the economic sector, no large-scale investments by multi-national corporations, no banking reform, and no effort to upgrade the agricultural sector so as to avoid having to import 70% of Cuba’s food. Growth rates plummeted to -0.9% in 2016, then rebounded a bit to 1.5% in 2017. Cuba’s GDP per capita is $7,600, much higher than North Korea’s but still less than China’s. Raul recently retired, though no one doubts he still runs things from his rocking chair.

Raul distrusts everything American, especially its big businesses that flourished in Cuba during the Batista regime that the Castros overthrew in 1959.  Once in power, the Castros’ forced fed the Cubans with their version of a socialist paradise, aided by 30 years of economic aid from the USSR. The Soviets played the Cuban nuclear deterrent card in 1963 – installing missiles that nearly led to a US invasion or nuclear exchange – from which they backed off.  However, without the support of the USSR, which imploded in 1991, Cuba experienced a very difficult, near-starvation, decade, only to be bailed out again by another socialist paradise, Venezuela.  Then, as Venezuela’s economy collapsed, Cuba had to look to other options to stay intact. If Raul did nothing, rising economic discontent might lead to the end of Cuban “Socialismo” after his death. If he patched things up with the US, the economy might rekindle and the regime could survive.

The Castros have long since ceased to be any kind of threat to the US, but their rule, like the North Koreans, is a testimony to the ability of an authoritarian police state to stay in power indefinitely, despite dreadful economic results. But it seems than both Raul Castro and Kim Jong Un saw handwriting on the wall – do nothing and our economies finally do crash and political change may be next. Do something with the US, and we can buy some time: sanctions may be reduced, and foreign money may be attracted to a less confrontational future.

Like the Castros, the Kims are a cautious family business unlikely to open up more than a little. Perhaps a little can go a long way if it makes local street market entrepreneurs happy. But, really big changes usually take a new guy to pull them off. Deng Xiaoping engineered China’s 180-degree turnaround strategy skillfully, but only after Mao Zedong, who launched the disastrous Red Guards to rekindle revolutionary ardor, had died and Deng had gained power.  

In Korea, post-summit meetings continue to see what might be done. Mr. Pompeo has said that he and Mr. Trump expect nuclear disarmament to be achieved by the end of the president’s first term, but sanctions will remain until it happens. Some observers who know, say disarmament is a process that will take a decade or more.  Some who know North Korea say the thirty-year effort to secure nuclear weapons and missiles was only to be able to deter threats from the US, its longstanding enemy-in-chief.  Maybe Kim will give up some stuff, as his father did in previous negotiations with the Clinton administration, but never all of it and not quickly without sanctions relief. Really big changes by North Korea seem hard to imagine.

In Cuba, a really big change didn’t happen with normalization because Raul didn’t want it to. For him, opening up Cuba’s economy to global investment entailed too big a risk of capitalism getting into the country and creating a surge of money and market forces that might overwhelm government policies, information and controls. What Raul did want was a repeal of the US trade embargo with Cuba. Mr. Obama may have been ready for this, but the Republican-controlled US Congress was not. To repeal the trade embargo will require restoration of human rights and property seized by the Castro government.  Nevertheless, some normalization is better than none. The US and the Cubans can wait for Raul, now 87, to pass on and then maybe somebody new will appear to make the really big changes Cuba needs and the US would welcome.

But Mr. Kim, in his thirties, isn’t about to pass on.  If the deal with Mr. Trump proves too risky, he probably figures he can back away as before. But, he may be in a tighter spot than he thinks.  The Americans may not be willing to trade unless they get everything they want, and Mr. Trump has promised to achieve disarmament one way or another. Both Trump and the Kim are dealing in a vast area of mutual misunderstanding and distrust, but with high expectations for political success.  Still, there is no need to rush -- North Korea’s nuclear threat to the US, never great or imminent to begin with, is “on hold.”

A Cuban type of slow-go in North Korea could be what both sides need. A few signs of good faith, lots of talks off stage, visits by diplomats, more aid and encouragement from South Korea and Japan, and who knows, maybe in time something better than the status quo ante will emerge.

It Could Only Happen in Italy

By Roy C. Smith

Though a founding member of the European Economic Community and of the European Union, and a first round participant in the euro, Italy has always posed an existential threat to these institutions because its heavily working class voting population has never trusted the so-called elites, was always suspicious that the wheeling and dealing politicians that came forth were corrupt or incompetent, and never felt very European.  

In 1946, after more than 20 years under Mussolini, Italy established by referendum a democratic republic. But Italy was not a normal country then; from 1943 when the Italians surrendered until well after the German forces exited in 1945, Italian partisans rose up aid allied forces fighting the Nazis, but also to seek revenge on Italian fascists and/or supporters of the Germans and their collaborators. As many as 30,000 Italian were killed by their countrymen in 1945 and 1946 alone.

For most of the next 50 years, however, the dominating political party was the center-left Christian Democrats, whose main job was to keep the Italian Communist Party (the largest and most accepted in Europe) from gaining control of a government. In these 50 years, however, Italy had more than 50 governments, as the Christian Democrats wheeled and maneuvered to stay in control through coalitions, alliances, pay offs and deals of various kinds. But, the Christian Democrats kept their hands on the tiller through this time (making Italy less volatile than it seemed), but voters continued to seethe with a long list of discontents (including too many politicians with their hands in the till).

In the 1970s, the extreme left Brigate Rosse (Red Brigades) emerged and introduced terrorism to Italian politics in a “Decade of Lead.” The group was not part of the Communist Party but seemed aligned in political objectives. In 1978 the Red Brigades assassinated prime minister Aldo Moro.  They have been associated with 14,000 acts of violence. But they had some public support from the working class, whose sentiments were portrayed by the hugely popular Italian comic playwright Dario Fo (Nobel Prize in Literature 1997) in The Accidental Death of the Anarchist and Can’t Pay! Won’t Pay! (Fo is now a mentor to the populist-left, protesting Five Star Movement founded by a popular TV comedian and social media blogger, Beppo Grillo, in 2009).

In the 1990s and 2000, Silvio Berlusconi, a media billionaire with characteristics resembling Donald Trump, entered politics and was elected prime minster three times, serving a total of 9 years, longer than any other post-war Italian leader.  Though a successful businessman, Italy’s economy lagged the EU average during this time, and unemployment was higher. Berlusconi never attempted any of the labor and other reforms that other countries in Europe were undertaking at the time. He was very popular with the working class - running for office as an in-your-face conservative but governing as a populist. In 1994 his first government was defeated and a “technocratic government” headed by a former government official was appointed to run things.

Berlusconi resigned again in 2011 during the European Sovereign Debt crisis, and economist and former EU commissioner, Mario Monti, was appointed prime minister of another technocratic caretaker government until 2013.

During this time, Matteo Renzi formed a new Democratic Party to bring about needed reforms and bring Italy into the European mainstream. He was elected prime minister at 39 in 2014, with 60% of the vote and immediately began to introduce long overdue labor reforms, and to modernize Italy’s state-owned-industries and sell off assets. Despite much opposition he was successful in getting labor and other laws changed. He also introduced a change in Italy’s constitution to reduce the power of the Senate and make the Italian legislative voting system more democratic. Though the constitutional reform had the approval of the legislature, it had to pass a referendum, which in late 2016 it failed to do. Renzi then resigned as prime minister.

Italy’s next election in 2018 resulted in a surprise victory by the Five Star Movement, which gained a plurality of 32.2% of the vote, beating out the Democratic Party (18.9%), still led by Matteo Renzi, that only barely outdid an upstart, far-right League Party (17.7%), forcing an awkward coalition attempt between the far-left and the far-right.  

This effort, which involved the designation of a prominent lawyer without government experience to be prime minister (instead of either party’s head, a difficult and cumbersome compromise) failed when the two parties proposed an 81-year old anti-euro former Bank of Italy economist to be Minister of the Economy.

President Sergio Mattarella, acting within the constitutional powers of his office, rejected the coalition proposal on the grounds that the election was not about leaving the euro, which the proposed ministerial appointment foretold, and voters did not know when they voted that the parties might attempt a ”back-door exit” from the currency system that Italy had supported from the beginning. Instead, President Mattarella designated Carlo Cottarelli, a former IMF official, to become prime minister and to form another (a third) caretaker government. This new government, though, is opposed by the two parties that are attempting the coalition, so it is certain to not gain parliamentary approval, therefore triggering a snap election in the fall of 2018.

Such an election may legitimately be presented as a referendum on the euro, which considering populist sentiment in Italy could result another ill-informed Brexit.  Referendums in Europe are dangerous things.

Mattarella was not eager to have an early election under these conditions, so he was open to a different proposal from the coalition - to appoi9nt a different Minister of the Economy and let the 81-year old economist take another position in the government. Talks continue, but meanwhile, interest rates on Italian government bonds rose by  150 basis points in just a day. 

Departing the euro would be far more painful to Italy than Brexit would be to the British. Leaving the euro would mean readopting the Lira, watching it fall in value relative to the euro and increasing the burden of Italy’s $3.2 trillion debt (173% of GDP) on its citizens, and limiting the availability of new credit to Italy’s government and private sector. Banks would be forced to curtail loans, interest rates and unemployment would rise, probably sharply. Growth rates would slump into a recession that could last a long time, like Greece’s. And, in its economic distress, it would get no help from the European Stability Mechanism or European Central Bank, which can only aid euro members. As in the case of Brexit (where the issue was leaving the EU, not the euro), it is unlikely that the average voter will be aware of these consequences of an anti-euro vote or believe what they are told about them.

All this could be worse for Italians if the Five Star/League consortium also choses to leave the EU, something that some of their fervent anti-immigrant advocates believe is necessary. Italy has been awash with immigrants from Africa for several years. Leaving the EU would mean leaving the custom union (the Single Market) and the Schengen Area (no passports needed) that could curtail Italian economic growth and inward investment flows further.

Some Italian observers believe that a September election will ignite the worse of Italy’s populist complaints. Mattarella, who believed the coalition’s government proposal was harmful to Italians of all classes, nevertheless is seen as being outrageously wrong in cancelling the results of a democratic election. The populists also believe that the “establishment” political parties are not listening to the common pleading of all Italians to limit immigration and unwanted, unfair pressures on Italian life by the EU that leaves too many Italians poor and unemployed. They want the government to extend social services further to help all who need it, whatever the cost. Italy’s government debt, already 131% of GDP (the highest in the EU except for Greece) would likely explode if the coalition’s announced plans to block immigration and increase social spending were implemented.

Italy’s EU allies, some of which are fighting similar political battles in their own countries, are powerless to help. They know that an exit from the euro by Italy would be a grave threat to the ability to hold the currency together. But also, that Italy could face a banking and sovereign debt liquidity crisis similar to that confronted by Greece, Ireland, Portugal and Spain. Such a crisis would be too big to handle, and beyond the limits of voters in Germany, Holland, Denmark and other countries to tolerate as a cost of being in the currency.

Brexit may not be enough to break up the EU, but an Italexit could break the euro.   

True enough, but this is Italy – anything can still happen.

  

China, Trade and Trump

By Roy C. Smith

Perhaps it is now not unusual in the age of Trump to send an inexperienced team of officials with differing views on trade to Beijing for a two-day photo-op to deliver their “demands” for adjusting the “unfair” US-China trade balance. Among the seven US delegates, only Robert Lighthizer, the official US Trade Representative, has expertise in negotiating the endless minutia of trade issues. Though nominally led by Treasury Secretary Mnuchin, no one on the delegation seemed to be in charge or to speak for the president, something Commerce Secretary Wilbur Ross knows very well - last summer he negotiated a deal with China to reduce steel production that Mr. Trump later rejected as insufficient.

The Chinese side, quickly banged together by Liu He, president Xi Jinping’s new economic chief, replaces officials from the Commerce Ministry that were the previous trade experts. Liu’s team, trained in economics and finance, but inexperienced in trade details, seems to be fielded particularly to respond to the Trumpian form of blustery, highly politicized negotiations.

Neither side knows each other very well. Mr. Lighthizer said “we are going to spend the next year developing how we deal with each other.” If so, Mr. Lighthizer must assume his Chinese counterparts will not respond to the demands soon, or even take them seriously until they know each other better.

The US demands were an opening salvo of an economic artillery barrage that will go back and forth for a while. They include a unilateral reduction in China’s trade surplus with the US of $200 billion by 2021 (increased from $100 billion indicated before the meeting, which the Chinese said would be impossible), the ending of subsidies to Chinese tech companies competing in world markets, an immediate end to cyberespionage of commercial trade secrets and a strengthening of intellectual property protections, a lowering of Chinese tariffs on products in “non-critical” areas, opening of Chinese markets to foreign investments and services, and a promise to take no action, especially in the agricultural sector, in response to unilateral US tariff increases and other moves. These include the recent US announcement of higher tariffs on $150 billion of Chinese exports, restrictions on acquisitions in the US by certain Chinese companies and of exports to China of certain high-tech products, and penalties imposed last month on ZTE, a Chinese telecom company, for violating US sanctions on Iran.

China has already said it might open its markets to easier terms for foreign investment and is considering lowering some tariffs, but was unwilling to commit unilaterally to slashing the trade deficit. China recently announced a Made in China 2025 program as an essential upgrading of the economy with an emphasis on high technology industries. On May 5, a day after the Beijing talks ended, China announced the formation of a $47 billion China Integrated Circuit Industry Investment Fund to advance the 2025 plan. The US objects to this plan because of the large amount of government subsidies it will contain.

So, a year-long set of trade negotiations has begun with both sides firmly dug in. Nothing much is likely to happen for a while. China is not in a hurry and doesn’t face mid-term elections in the fall.  

But, China too has large political interests at stake in these negotiations. Newly anointed president-for-life Xi Jinping is in the process of consolidating all powers in China in the Chinese Communist Party (and himself).  His propaganda machine is constantly busy promoting Xi’s dynamic leadership, his “thought” and his “Chinese dream” even though growth is slowing, financial risks are increasing, and the problems of China’s huge aging population are becoming apparent. Like Mr. Trump, Mr. Xi has a populist side that appeals to nationalistic sentiments that the propaganda folks keep warm. He wants China to be recognized by the US and other countries as a great power, and not appear as Japan in the 1980s, so driven by economic ambitions that it could be forced into concessions by the US. Indeed, after the recent negotiations with the US team, Xinhua, China’s official news agency, pointed out that in a trade war, China was better off because of its strong centralized leadership, strong domestic consumer base, and “greater desire” (than the presumably soft Americans) to protect the current global trade system.

Mr. Trump’s style of deal-making is not unique in trade negotiations. Indeed, Richard Nixon, frustrated that Japan was not conceding to his trade policy demands, suddenly imposed a 10% surtax on all Japanese imports to the US. Japan responded by offering some concessions on quotas that solved the political problem Nixon had with US job losses for a while. But the trade imbalances continued and Ronald Regan followed a similar strategy a decade later.

China has emphasized that it is in a stronger bargaining position than Japan in the 1980s. Maybe it is, but the US is China’s largest trade partner, and its open markets continue to be important to China’s future. Meanwhile, China’s economic growth rate has declined from the 10% range to something around 6% despite enormous stimulus efforts and lose credit standards that threaten its financial stability. A trade war with the US certainly would not be convenient.

Economic forces already at work, however, will reduce the trade deficit on their own over time – rising costs for labor, land and raw materials have already caused some companies to move their manufacturing to a lower cost locale, and China will have a growing requirement to import goods as it becomes more of a market-driven consumer society. Meanwhile, while the deficits remain, US consumers enjoy lower prices and corporations pay lower interest rates as China recycles the surplus to invest in US securities, factories and acquisitions to protect its global market access. A great many Americans benefit a little from our present trade with China, but a few have lost their livelihoods. Cold-blooded economists don’t lose any sleep over the disparity, but hot-blooded politicians do.

China was admitted to the World Trade Organization in 2001 at president Bill Clinton’s strong urging. The US trade deficit with China was then less than $100 billion (it is now $375 billion, 2% of US GDP). China was granted some relief from WTO rules because it was a developing country. Some say because of China’s enormous growth since then, and the impact of its concentrated export activity on local businesses in the US and the EU, China should be regarded as a fully developed country and play by all the rules. China says with 60% of its population still poor and an urgent need to upgrade local manufactures to supply local markets, it should not be required yet to do so. And, China is still a one-party state with 150,000 state-owned enterprises that retains many aspects of the command economy it once was.

What's needed now is a set of practical compromises that both sides can live with and feel good about because they add real value.

These might start with a revised accounting system for calculating export values – The iPhone X costs about $370, according to one expert, for its various software and hardware components. Chinese content for assembling the units, however, is only 3% to 6%, or only $10 to $20 per unit. (The rest goes to companies in South Korea, Japan, Taiwan, the EU and the US, illustrating how Apple’s global supply chain works). On the other hand, Chinese content of commodity items like steel exports is nearly 100%.  If we ran the accounting to count only Chinese content, the pressure points would be different. China has excess and unprofitable capacity in steel and other commodity items that China needs to shut down in its own interest. If they are not shut down, the US can file dumping charges with the WTO and impose a special tariff on steel. Such tariffs have been imposed by almost all of Mr. Trump’s predecessors on a case-by-case basis. Mr. Trump could score some points by claiming his metal tariffs would be used for job retraining for displaced workers. But shutting down excess capacity, as Mr. Ross tried to do would be better. China knows it must do this sooner or later and would be better off doing so now.

Mr. Trump might propose that China agree to use its best efforts to offset the adjusted, net trade deficit with the US by increasing imports from the US, which could be of agricultural commodities, liquid natural gas (soon to be abundant in the US) and various forms of financial and other services. An accounting could be kept, and the process monitored to be sure that China conforms to the agreement, but how it does so would be left to it.

A special US-Chinese unit could also be established to continually monitor and address mutual security issues. The US wants to be sure that Chinese hacking of commercial trade secrets is ended and intellectual property protected. The Chinese want to be able to develop their technology industries, which the US should not object to if the effort conforms with restrictions on government subsidies recognized by the WTO and the EU. The US should leave private sector trade and investment in the high-tech sector to market forces, except for highly specific cases involving national security.

Having had the necessary dramatic opening session to satisfy local populations that each country is hanging tough on this important round of trade talks, it is time to get them off the stage and settled into quiet discussions of the complicated but hugely important trade relations between the two countries. A pragmatic solution awaits.

RIP: Mother of the Modern EU Her Party Wants to Leave

by Roy C. Smith

 

Margaret Thatcher died five years ago this week. She would have hated the debacle of the Brexit vote and the shambles that have followed, because she did more than anyone to shape the modern European economy in which she wanted Britain to play a leading role.

When she became prime minister, the EU was the European Economic Community, a stodgy assemblage of 12 countries hoping for benefits of integration but badly in need of reform and rejuvenation. She was a true believer in free markets, deregulation and competition and on reforming and rejuvenating Britain after decades of weak economic performance and currency depreciation. Right away she repealed foreign exchange controls that had been in place since 1914, cut income taxes and battled unions. But she had a larger vision – to “privatize” hundreds of state-owned-enterprises (many of them nationalized by previous Labour governments) that then represented 10% of the UK GDP. Doing so would return billions of pounds to the Treasury, enable collection of taxes on profits, and return the companies themselves to being competitive in world markets. And, ordinary Britons could become capitalists by buying shares in great British companies. A long stream of British privatizations in coal, iron and steel, automobiles, gas, electricity, water supply, railways, trucking, airlines, airports and telecommunications began in 1981.

But for privatization to occur on a large scale, multi-billion £ stock issues would have to be sold. The financial infrastructure of the City of London, however, was antiquated and not up to handling such large issues. The City also needed to be reformed along free market lines, with the chips falling where they may. So “Big Bang,” announced in 1983 to be implemented in 1986, came into being and did the job. Simply by forcing the London Stock Exchange to negotiate commissions, allow “dual capacity” (of trading and sales, etc.), and open membership to all qualified comers, the system was transformed into Europe’s most competitive and efficient financial marketplace. Not long afterward, all of the countries in the EEC, fearing that the securities business in their countries would migrate to London, copied the Big Bang example and modernized their systems too. They followed her example, not some decree published in Brussels. Today, integrated European capital markets are the largest segment of the global capital market. In 2017, they generated over $4 trillion of new debt and equity issues, more than in the US market.

By the end of Thatcher’s term in office, more than 50 British companies worth more than £50 billion were privatized, restructured and made competitive. Soon it was clear to other EEC governments that privatizations worked, were popular with citizens, and generated returns of capital and tax revenues that eased governmental finances considerably. By the late 1980s, all of the other EEC countries were actively engaging in large privatization issues of their own. They in turn were followed by IPOs and other equity market transactions that transformed the closely-held private sector of Germany, France, Italy, Spain and other countries.

But Thatcher was not content to limit her reform ideas to Britain. In 1984 she appointed euro-skeptic Arthur Cockfield to be a member of a European commission studying economic reforms. Like Thatcher, Cockfield was a strong advocate of free markets; he arrived with a lot of data and a lot to say about integrating and liberating European trade and industry. He was the driving force behind the Single Market Act of 1986, the EECs most import reform effort. It incorporated the “Four Pillars” of the EU (freedom of movement across EU borders of goods, services, labor and capital) that was formed a few years later. After implementation of the Single Market, every company in Europe had to reconsider its business model and strategy. They were now part of a much larger, integrated marketplace and nationally protected local market dominance became a thing of the past. This strategic rethink, together with revitalized securities markets, lead to the first-ever European M&A boom that began around 1985 and has continued since, making it a vital part of a global M&A market that periodically does more transactions in Europe than are done in the US M&A market.

Finally, after forcing through financial reform, privatization and the Single Market act with its ensuing merger boom, Thatcher appeared in Bruges, Belgium in September 1988 for her now-famous address to the College of Europe on Britain’s future role in the EEC. She began her remarks by saying that “if you believe some of the things said and written about my views on Europe, it must seem rather like inviting Genghis Khan to speak on the virtues of peaceful coexistence!”  But she explained, “Britain does not dream of some cozy, isolated existence on the fringes of the European Community. Our destiny is in Europe, as part of the Community.”

She also acknowledged that Britain under her leadership had fought back over regulation and other issues that she thought were unnecessarily constraining to the UK. Then she added her nest remembered line: “We have not successfully rolled back the frontiers of the state in Britain, only to see them re-imposed at a European level with a European super-state exercising a new dominance from Brussels.” But, this did not mean she wanted to leave Europe, only to use the UK’s powerful influence and example, as she had successfully been doing, to persuade Europe to maximize the utility of the private sector and minimize the notion of a super-state.

She was never a believer in go-it-alone, nor did she ever deviate from the basic idea that a great country like Britain had to be part of the global scrum to influence it. She would never have agreed to the Faustian bargain that David Cameron made with his backbenchers to offer a dangerous referendum on EU membership in exchange for their support as party leader, and she certainly would have hated the result.  

Britain’s post-Brexit future is certainly unclear. But what is not unclear is the enormous transition of financial markets, the vitality of the private sector and operational effectiveness of the EU’s integrated private sector that is now the world’s second largest GDP (at purchasing power parity), just behind China and ahead of the US, serving more than 500 million people. No one was more influential in bringing this to be than Mrs. Thatcher.

Lloyd’s Voyage

By Roy C. Smith

Friday's news that Lloyd Blankfein would retire from Goldman Sachs at year end was a surprise to almost everyone. He will have served 12-years as Goldman’s CEO, longer than anyone else except Sidney Weinberg (who retired in 1966), and is one of the longest serving CEOs among today’s major banks. Blankfein replaced Hank Paulson as CEO in 2006, having transformed the firm’s Fixed Income, Currency and Commodities division into a trading powerhouse that was arguably Wall Street’s most dominant player.

Indeed, trading accounted for 68% of firm-wide revenues in 2006, and 73% of profits. Goldman Sachs’ return on equity was 33% and its price-to-book ratio was about 2.0. The stock was trading at $170 per share then, more than three times its IPO price in 1999. Blankfein, originally hired by the J. Aron division as a gold trader, took over the FICC division in 2002 and initiated a massive change in the orientation of the firm from traditional investment banking to a wide-ranging trading colossus that operated around the world and around the clock in hundreds of different instruments. 

Extraordinarily for the securities industry, this enormous growth and transition was accomplished without any major acquisitions, or dilution of ownership that such acquisitions cause. The expansion was accomplished entirely in house, working with that wonderful Goldman Sachs DNA that is both feared and revered throughout Wall Street and the City.

Blankfein, however, had little time to enjoy his and the firm’s achievements. Soon after taking over from Paulson, he and other analysts noticed that rising housing prices, upon which a boom in mortgages and mortgage-backed securities was built, had ceased and indeed, reversed direction. Realizing that this could mean an end to the boom (or worse) he ordered a reduction in Goldman’s trading inventory, a reduction that was strongly opposed by some of his trading barons. He prevailed in the struggle that ensued, however, which some his counterparts (at Citigroup, Merrill Lynch, and Morgan Stanley) did not, and steered Goldman Sachs through the financial crisis that followed with barely a scratch. Later, however, he had trouble explaining to Congress why the firm periodically adjusts its own exposures to its future outlook, without consulting its trading counterparties that were simultaneously adjusting their own positions. In the end, Goldman Sachs agreed to a $550 million settlement with the Justice Department for infractions of this sort.

After the financial crisis of 2007-2008, Goldman Sachs went through a number of regulatory changes that permanently altered its business. After the Lehman failure, the Federal Reserve required Goldman to became a bank holding company, which provided some advantages but many costs and disadvantages as well. Basel III and Dodd-Frank, and their myriad parts and pieces, came into effect imposing vastly increased regulatory compliance costs and greatly limiting the firm’s freedom of maneuver. There was no escaping this – Goldman had about $1 trillion of assets and was clearly a “systemically important financial institution,” so it had to change its business model to accommodate the new limitations.

Twelve years after Blankfein’s succession, Goldman’s total revenues are less than they were in 2006, and for 2017 trading represented only 37% of revenues, nearly half of what they were then. The stock price is about $100 per share higher, but the price-to-book ratio is only 1.46 (after a 20% increase in the stock price in the last six months), and return on equity was 10.8%.  Indeed, most of Blankfein’s tenure as CEO has been spent surviving the crisis and reengineering the firm for a duller, less expansive future. If he is feeling some regulatory fatigue, we can forgive him for looking for something else to do at 63.

It is curious that Blankfein’s retirement announcement should come so close to Gary Cohn’s, his former deputy who left last year to join the Trump team. There may be some wondering whether there will be a job switch, in which Blankfein would follow his Goldman CEO predecessors John Whitehead, Bob Rubin, Steve Friedman and Jon Corzine to Washington, and Cohn would come back to pick up where he left off but enriched and fortified by his White House experience. Don’t count on it – these things are rarely so simple – Blankfein has been more politically active as a Democrat than Cohn was, and in any case may be fearful of losing reputation by association with Mr. Trump’s team. And, though Cohn has had a full-career at the firm, as every Goldman Sachs CEO has before him, the water filled in behind him when he left and others are in waiting.

So maybe, now having been a king, Lloyd Bankfein, will be content to lay back and be a philosopher, author and philanthropist, as his predecessor, Hank Paulson, and friend Michael Bloomberg have done. Why not? He’s earned a good rest and some peace and quiet.

from Financial News,  Match 12, 2018

How Wrong is Trump on Protectionism?

How Wrong is Trump on Protectionism?

Roy C. Smith and Ingo Walter

It’s hard these days to find anyone concerned with the national interest who hasn’t been raised on the idea that tolerably efficient markets are better than rigged markets. Properly structured, they help ensure that resources are put to best use and the public has access to the best products and services at the best price. And when things like technology or consumer preferences shift, market discipline assures structural change in the economy to redeploy resources from activities of the past to those of tomorrow. Of course there are always winners and losers – for sure in the short term – and adjusting to new realities can be painful, But in the end the system is stronger and grows faster than under any other arrangement that’s ever been tried. Best of all, market-based opportunities and market discipline works with human nature, not against it.

That’s the way it is with international trade and the notion of comparative advantage. People, companies and countries should focus on what they do relatively better than others and acquire what they don’t, each on terms determined by the market. In so doing, their welfare will be higher and its growth will be faster than it would be otherwise. Deviate from this principle, and a price will have to be paid in the form of lower welfare and slower growth.  There’s no way around it.

So what happened with President Trump’s plan to impose high tariffs on steel and aluminum imports (with some negotiated exemptions) and then doubling-down on protectionism by hitting China on an array of “sensitive” products?

Maybe he and his advisers don’t believe basic economics. Maybe they believe international markets are already rigged, so a bit more won’t hurt. Maybe they think that we’ve done a really bad job getting people in distressed industries redeployed, so they deserve a break paid-for by healthier sectors and the general public. After all, politics is politics. And people who believe they are facing a bleak economic future – often an existential threat - form a powerful voting block. Meanwhile, those who will pay the tab for protection may hardly feel it and must rely on arguments based on the overarching principle of liberal markets. It can be an uneven political battle at times. And it’s never hard to point to other countries’ protectionist practices – in trade policy and liberal market access, nobody has clean hands.

But there are plenty of cheaper and more effective ways of addressing the kinds of “fairness” issues that give rise to today’s protectionism. Admittedly, the US has had a poor record of walking the talk and successfully and efficiently helping to redeploy resources, notably labor. Farmers say there are two ways to harvest corn. One is conventional way in the cornfields. The other is to go behind the barn and seek-out the few whole kernels left in the hog manure. The Trump plan seems to fit squarely in the second category, an economic blunderbuss that will hit importers, supply chains, exporters, foreign markets that take massive amounts of US exports, consumers - and maybe the US economy as a whole as some benefits of the Trump tax cuts are wasted on the inevitable costs of protectionism.

Besides the directly affected products in the Trump target-zone and those hit by retaliation, at stake here are the rules of the game that allow the benefits of market economics to work its magic on a global scale, where trade and specialization form one of the key drivers lifting welfare and growth among billions of people worldwide. Since 1937 the US has been the most important advocate of letting global markets do their work. The US has been instrumental in launching every round of global trade negotiations, and every President across the political spectrum from Roosevelt to Kennedy to Nixon and onwards has identified America’s national interest fundamentally with pursuing freer international trade in both goods and services. The core principles are “non-discrimination” in how market-access is opened to competitors, domestic versus foreign, one country versus another, together with “reciprocity” – we open our markets to foreign suppliers in return for their opening markets to ours. Both can be lumped into “fairness,” as in Trump’s “free and fair markets.”

The fact is that well-functioning markets need rules that anchor its basic principles, along with effective dispute settlement procedures. Again the US was the motive force behind both the 1947 General Agreement on Tariffs and Trade (GATT) and later the World Trade Organization (WTO). And when countries want to accelerate the efficiency and growth benefits of freer markets, something that may not be possible on a global basis, they may set up regional trade arrangements like the original European Economic Community (now EU) or the North American Free Trade Association (NAFTA) – not quite as beneficial as freer global markets, but better than the status quo. That option has likewise been under Trump policy assault in the case of both the Trans-Pacific Partnership (TPP) and NAFTA.

By apparently ignoring the factual power of globally freer markets, the Trump Administration betrays a critical US legacy based on a core belief in market outcomes that has overwhelming evidence to back it up. It also betrays America’s legacy of leadership in creating the global institutions to make it happen, cumbersome as they might seem at times. It puts the US on a slippery slope to some bad outcomes that will gradually become apparent and begin to poison the political chalice. In any case, the Trump tariff increases on steel and aluminum slam the EU and Canada and Mexico, among the leading US partners in seeking to assure sustainably accessible global markets. All three have their own protectionist practices that have not been successfully negotiated over the years, and all three have received Trump exemptions. Shooting yourself in the foot is not the best way to change the behavior of others.

But wait! Maybe Trump actually has a coherent plan, with a bulls-eye painted on China. Everything else may be a side-show – with the Europeans and others quietly cheering him from the bleachers.

Does China practice trade fairness market discipline? Hardly. China takes few prisoners in state support for exports and strategic investments abroad, stiff-arming foreign players in its domestic markets when it suits them, or in the murky calculus of state-owned businesses and banks. And there’s not much light between political targeting and competitive targeting in China. Non-discrimination and reciprocity often don’t seem to be in the Chinese vocabulary. It has violated key commitments under the WTO since it joined in 2001. But like Japan a few decades earlier, China has increasingly come under tough pressure from trading partners to play by the all-important rules of global trade and take its share of responsibility for a viable trading system. Toddlers are cute to have around the house, but not after they grow to 300 pounds.

Most importantly, China will eventually feel the effects of the kind of resource misallocation that results from persistently violating the spirit of those rules. Candidly, Chinese will often say “we will adjust, but on our schedule and terms, not yours.” China to Trump on protectionism in Twitter-speak:  “Won’t work. All wrong. Really bad.”

But Trump is also very good at borrowing ideas. His trade initiatives echo targeted measures taken by Richard Nixon, Ronald Reagan and George W. Bush over the years.  Each was intended to be shocking, but ended up with some voluntary or negotiated settlements, enough anyway to take the item off the political stage and allow a victory lap. By this logic, Trump aims to make a fuss over China tariffs, which can end in trade arrangements that will entail some backing-off and avoid a downward spiraling trade war that nobody wins. Trump could even include some sort of "surtax" on certain imports with sufficient proceeds (perhaps a few billion) to fund another try at a national worker retraining program – and sell it as a fair price to be paid by millions to fund assistance to the small number who are hurt. Could be a plan, if it can be made to work. But then, Trump is also very good at changing his mind.