The Capital Note

The Capital Note: China Bulls Shop, Europe’s Sour Grapes

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Welcome to the Capital Note, a newsletter about business, finance and economics. On the menu today: China’s successful bond issue, America’s high tech (and the resentment it generates in the EU), China’s Covid exports (no, not that one) and the end of risk-free assets.

China Bulls Shop
U.S. investors facing meager returns on developed-market bonds bought up record amounts of Chinese sovereign debt in a bond offering today. According to the Wall Street Journal, U.S. investors bought at least $250 million of the $6 billion dollar offering (the actual figure, while unknown, is likely higher), which sold at a relatively small premium to risk-free U.S. debt.

Yields on Beijing’s three-year bonds exceeded those on corresponding U.S. Treasuries by 0.25 percent, while 30-year bonds sold at a 0.8 percent premium — lower spreads than those on a similar Chinese bond offering last year. That’s a vote of confidence in Beijing’s recovery from the pandemic, and a sign that foreign investors do not see Chinese debt buildup as a major cause for concern.

It also sends a signal as to Beijing’s economic strategy. Chinese leaders have for years indicated that they intend to integrate the country into the global financial system. While capital controls show no signs of abating, dollar-bond offerings offer a higher degree of exposure to foreign investors while also setting a borrowing benchmark for corporations. Dollar lenders to Chinese businesses can use the Chinese dollar-bond yield curve to set borrowing rates, making it easier for those companies to tap the capital markets.

Foreign-exchange fluctuations may also play a role in the offering. The timing works in China’s favor, as the dollar has depreciated against the renminbi in recent months. At the same time, dollar-bond issuance diverts portfolio inflows away from renminbi-denominated bonds, which have surged this year and contributed to the strength of China’s currency.

The renminbi’s appreciation has not put a dent in exports, so Beijing is unlikely to be alarmed by exchange-rate fluctuations. Indeed, the People’s Bank of China has uncharacteristically refrained from intervening in currency markets of late. That being said, they are likely cautious that continued renminbi momentum could destabilize the economy, especially given the uncertainty around the next U.S. administration’s approach to China.

— D.T.

Weaponizing Antitrust: The EU vs. Silicon Valley
One of the great documents in the history of central planning is the effort from 2000 that launched the EU’s Lisbon strategy, a piece of work to which I occasionally turn for the sheer mean-spirited fun of it, sometimes to read sections like this (emphasis in original):

Implementing this strategy will be achieved by improving the existing processes, introducing a new open method of coordinationat all levels, coupled with a stronger guiding and coordinating role for the European Council to ensure more coherent strategic direction and effective monitoring of progress. A meeting of the European Council to be held every Spring will define the relevant mandates and ensure that they are followed up.

But above all, for this:

“The Union has today set itself a new strategic goal for the next decade: to become the most competitive and dynamic knowledge-based economy in the world, capable of sustainable economic growth with more and better jobs and greater social cohesion.”

Fast forward to the end of that decade — 2010 — and we see that the planners have prevailed, that Seine.Fr has become the world’s greatest online retailer, that a social media company originally set up by students at the Sorbonne is signing up tens of millions of subscribers, that Germany is as well-known for its search engine giant as for its engineers, and that Italy’s Mela has launched a telephone that has amazed the planet.

Well, perhaps it didn’t work out quite like that.

Confronted by the reality of its failure to create the most competitive and dynamic knowledge-based economy in the world™ by 2010 (a year, ironically, in which the consequences of another of the EU’s adventures in central planning — the euro — had become all too visible), those leading the EU and some of its member states turned their hands to something at which they were better suited — destruction, rather than creation.

Specifically, they increasingly began turning their attention to ways in which they could hobble the high-tech giants that the U.S. kept producing. Most notoriously, they weaponized antitrust, a technique taken to absurd extremes by Margrethe Vestager, the EU’s competition chief, who argued that Ireland’s tax policy was too competitive (it was too favorable to Apple, you see). Even though the Irish government argued that it should not have the money, Vestager’s department attempted to insist that Dublin hit Apple with a retrospective tax bill of $15 billion.

This, as I noted back in July, was too much even for the usually docile European Court of Justice. It ruled that the Commission had failed to prove that Apple had received illegal state aid from Ireland through favorable tax agreements. Meanwhile, in addition to serving a second term as the competition commissioner Vestager has a new role. She is the Executive Vice President of the European Commission for A Europe Fit for the Digital Age, a pompous title, but don’t laugh too hard. When it’s awarded to a protectionist, that doesn’t bode well for American tech companies.

After all, as Quartz reported as far back as 2015:

If anyone thought European Union digital commissioner Günther Oettinger was bluffing when he recently suggested… the EU might rein in big internet companies like Google, Facebook, and Yahoo, they may not think so now. According to leaked documents from Oettinger’s office, the EU has been mulling the idea of establishing a new regulator to aggressively go after dominant (and mainly US-based) web platforms, essentially clearing the way for European competitors.

And in 2014, the European Parliament passed a (symbolic) resolution calling for the break-up of Google. As I observed at the time:

Whatever one may think about Google and the way it sometimes conducts its business, it’s important to understand that so far as the EU parliament is concerned, the company’s real offense is being successful while being American.

Fast forward to 2020, and to this Financial Times article by Richard Waters from last week:

For now, Europe looks set to take up the running against Big Tech. Unlike Washington, Brussels has already tried antitrust enforcement. Three cases against Google set the standard for trying to hold tech power to account. But the remedies that were meant to correct the perceived competition failures have proved to be a case of too little, too late.

That is, of course, one way of looking at it

And (my emphasis added):

Brussels is also further ahead in thinking through the lessons from this and trying to tighten its laws to reflect the new realities of digital monopolies. The outlines of potential legislation are starting to emerge, in the shape of a broad-ranging Digital Services Act.

The European prescription begins with forcing the Big Tech companies to share data collected through their platforms with smaller rivals, a move designed to break the cycle that locks in the leaders of the data economy. The law would also limit their ability to set a preference for their own services, for instance preventing Google from inserting its own maps or local listings above its general search results, and Amazon from favouring in-house products. And it would limit their ability to have their services pre-installed on consumer gadgets, something that squeezes out competitors.

Even these measures, though, might not be enough. Brussels has also been pondering drastic new enforcement powers. These include the ability to force changes in dominant companies’ business practices without a full investigation or proof that the law has been broken — an idea that would provoke a storm of protest from across the Atlantic.

As it should. And any protests should be accompanied by strong retaliatory measures as well. However, in the current climate in Washington that may not necessarily be how things turn out, whoever is in charge.

And this is not a challenge that can be wished away.

From today’s Financial Times:

US tech giants are facing the threat of an EU attempt to break them up after France and the Netherlands jointly issued a call for the bloc’s competition authorities to take pre-emptive measures as they prepare sweeping legislation to curb the companies’ market power.

Cedric O, France’s digital minister, and Mona Keijzer, the Netherlands state secretary for digital affairs, have signed a position paper calling on regulators in Brussels to take swift action against emerging tech giants and existing “gatekeeper” platforms — including options to break them up.

The most significant thing in that story is that the Dutch government is standing alongside its counterpart in France.

As the FT points out:

Paris and The Hague have traditionally held divergent views on how to regulate the tech industry, with the French government leading the push for stringent laws against everything from illegal content to strict data protection measures.

The Netherlands has historically taken a more liberal approach, but has joined a call for tough enforcement of competition rules to prevent tech giants favouring their own services to crowd out rivals and “entrench” their market dominance.

Ms Keijzer said regulators should aim for rules that prevent platforms from becoming “too big” in the first place. But added: “Breaking up big companies can be a possibility.”

“Breaking up [companies] is on the table. But this is the ultimate remedy,” said Mr O. “France and the Netherlands have different cultures and come from different positions. But we have a common interest, from a sovereignty point of view, from a competition point of view to regulate tech players.”

What is interesting about those comments is not the antitrust boilerplate, but the assumption that the Dutch and the French governments share a “sovereignty point of view.”

The mercantilists are coming.

Although Silicon Valley is not covering itself in glory at the moment, those American politicians dreaming of tearing big tech apart should think long and hard about effectively aligning themselves with a European political class motivated not only by anti-American animus, but also by an unwillingness to accept why the Lisbon Agenda was always doomed to fail in an EU in love with planning and hostile to free enterprise.

Theirs is not an example to follow.

— A.S.

Around the Web
The end of risk-free assets:

We have witnessed some rather unprecedented market moves in recent months, with government bonds falling along with equities with increasing regularity. In a repeat of 2018, the correlation between haven and risky assets went positive at times. This should really come as no surprise. With central bank purchases flooding the financial system with cash, the “buy everything” trade was the right thing to do.

China’s COVID export surge:

China’s export performance this year has been stronger than expected. After a sharp slump at the beginning of 2020, the country’s exports have posted positive growth—the only major economy’s to do so. However, a closer look at the data reveals that this growth has not been very broad-based, but rather concentrated in areas where China’s export structure was well-positioned to take advantage of the global crisis—namely, production of medical supplies and school-from-home and work-from-home (S/WFH) goods.

Private-equity billionaire reaches settlement with DOJ over taxes:

Robert Smith, the billionaire chief executive of Vista Equity Partners, has reached a $140 million settlement with the Justice Department, ending a yearslong criminal tax probe, according to people familiar with the matter.

As part of the settlement, Mr. Smith will enter into a nonprosecution agreement, the people said. He will admit liability for additional taxes owed and not properly filing foreign bank account reports but won’t be prosecuted. He will agree to abide by certain conditions set forth by the government, the people said.

— D.T.

Random Walk
The “Washington consensus” is a term that was originally used to describe the package of broadly market-friendly policies that should, to a greater or lesser extent, be preconditions for an IMF or other rescue of a troubled emerging market economy. The term was first devised by economist John Williamson in a paper (you can find it here) from some thirty years ago in which he “identifies and discusses 10 policy instruments about whose proper deployment Washington can muster a reasonable degree of consensus.” Although this consensus has come to be caricatured as insisting on a form of free market fundamentalism, Williamson summed it up best when he wrote:

The economic policies that Washington urges on the rest of the world may be summarized as prudent macroeconomic policies, outward orientation, and free-market capitalism. It practices the last of these with more consistency than the first two, but that should not be taken to imply that they are less important.

Williamson emphasized that:

The 10 topics around which the paper is organized deal with policy instruments rather than objectives or outcomes. They are economic policy instruments that I perceive “Washington” to think important, as well as on which some consensus exists. It is generally assumed, at least in technocratic Washington, that the standard economic objectives of growth, low inflation, a viable balance of payments, and an equitable income distribution should determine the disposition of such policy instruments.

But do such reforms work?

In a study for The Journal of Comparative Economics, Kevin and Robin Grier note that “traditional policy reforms of the type embodied in the Washington Consensus have been out of academic fashion for decades”, not least because of the way that it came to be interpreted:

We argue that the policy reform baby was prematurely thrown out with the neoliberal bathwater…

However, we are not aware of a paper that convincingly rejects the efficacy of these reforms. In this paper, we define generalized reform as a discrete, sustained jump in an index of economic freedom, whose components map well onto the points of the old consensus. We identify 49 cases of generalized reform in our dataset that spans 141 countries from 1970 to 2015. The average treatment effect associated with these reforms is positive, sizeable, and significant over 5- and 10- year windows…

What they found:

  • Sustained economic reform significantly raises real GDP per capita over a 5- to 10-year horizon.
  • Despite the unpopularity of the Washington Consensus, its policies reliably raise average incomes.
  • Countries that had sustained reform were 16% richer 10 years later.

H/t: Marginal Revolution.

— A.S.

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