Monday, August 31, 2015

All of That Dollar Borrowing in Emerging Markets Looks Like It's Been One Giant Carry Trade

Since the 2008 financial crisis, companies across emerging markets have been borrowing dollars and converting them into local currencies as part of a massive carry trade. This practice has helped U.S. dollar shadow banking go global as the effects of near-zero U.S. interest rates seep into all corners of the world economy.
That's the main finding of a new report released Thursday by the Bank for International Settlements, an institution in Basel, Switzerland, known as the central bank for central banks.
The paper, co-authored by Valentina Bruno, a finance professor at American University, and BIS Economic Adviser and Head of Research Hyun Song Shin, serves as a follow-up to a report released by the bank in January that found firms outside the U.S. have borrowed $9 trillion in U.S. dollars, up from $6 trillion before the global financial crisis.
The new study aims to get to the bottom of what those companies have been using the money for. Perhaps surprisingly, the evidence shows that firms which tend to borrow in dollars are not cash-strapped and are actually in better financial shape than those that don't, suggesting that the motivation for the borrowing has less to do with funding actual investment projects or other types of spending.
Instead, it looks like they've been using the cash at least in part for "carry trades," a term used to describe a popular investment strategy in which traders borrow in one currency at a low interest rate and 

Saturday, August 29, 2015

The road to digital success in pharma: McKinsey & Co.

Pharmaceutical companies are running hard to keep pace with changes brought about by digital technology. Mobile communications, the cloud, advanced analytics, and the Internet of Things are among the innovations that are starting to transform the healthcare industry in the ways they have already transformed the media, retail, and banking industries. Pharma executives are well aware of the disruptive potential and are experimenting with a wide range of digital initiatives. Yet many find it hard to determine what initiatives to scale up and how, as they are still unclear what digital success will look like five years from now. This article aims to remedy that. We believe disruptive trends indicate where digital technology will drive the most value in the pharmaceutical industry, and they should guide companies as they build a strategy for digital success.

Trends reshaping healthcare

Outcomes-based care is moving to center stage
Payors and governments have an ever sharper focus on managing costs while delivering improved patient outcomes, putting an even greater onus on pharma companies to demonstrate the value of their drugs in the real world—not just in randomized controlled trials—if they are to retain market access and premium pricing. In this environment, digitally enabled “beyond the pill” solutions, which include not just drugs but also sensors to collect and analyze data to monitor a patient’s condition between visits to healthcare providers, are becoming critical to serving both parties’ needs. These solutions help drive the adherence to treatment and outcomes that payors and governments seek, and they generate the data that pharma companies need to demonstrate their drugs’ superior efficacy.
Patients are becoming more engaged
In a digital age, patients are much less dependent on their doctors for advice, increasingly able and willing to take greater control of their own health. They feel empowered by the vast amount of health information available online and on apps, and by the array of health and fitness wearables such as FitBit and Apple Watch. In one survey, more than 85 percent of patients said they were confident in their ability to take responsibility for their health and knew how to access online resources to help them do so.1 In addition, patients are becoming keener to evaluate different healthcare products and services given that they bear a growing proportion of the costs. In a digital world, the ability to engage with patients as they make such evaluations could be key to the success of a pharma company’s commercial model.
New competitors are moving in
Information and insights into patients’ histories and clinical pathways are no longer the preserve of the traditional healthcare establishment. Where once health providers’ paper-based medical records were the main source of patient health data, and drug research and development data were kept within the walls of the pharma companies, today, technology companies such as Apple, IBM, and Qualcomm Technologies are moving into healthcare. They are able to engage with patients through apps, health and fitness devices, and online communities, for example. And they are able to collect petabytes of data from these and other sources, such as electronic medical records and insurance claims, capturing valuable insights. For example, the IBM Watson Health platform—recently at the center of a partnership with Apple and its HealthKit health-sensor data platform—is using advanced analytics and natural-language-processing capabilities to deliver clinical decision support. Pharma companies will need to decide soon how to position themselves to compete or collaborate with these new players, or build complementary capabilities.
More information is available about product performance
Historically, pharma companies have controlled both the generation and dissemination of information about their products. Digital technologies have weakened that control, opening an array of new, independent information channels. There are online communities for sharing and discussing patients’ experiences, apps and sensors to monitor the impact of therapy on a patient’s daily life, and advanced data aggregation and analysis to link disparate, complex data sets and generate new insights into drug safety and efficacy. In response, pharma companies will have to build the capabilities to anticipate or react rapidly to these new sources of evidence, and remain the main source of authority on the performance of their products.
Process efficiency and agility is improving dramatically
Advanced analytics, sensors, and the automation of complex decisions are capable of delivering a step change in the efficiency, speed, quality, and responsiveness of business processes in all industries. The pharmaceutical industry is no exception. To thrive in a digital world, pharma companies will need to deploy next-generation technologies to streamline their business processes. They need to achieve near real-time transparency of their clinical-trials portfolio in R&D, for example, and frictionless sales and operations planning in the supply chain, as well as meet new expectations in efficiency and agility from customers, employees, patients, and suppliers.

Four areas of digital opportunity

Against this backdrop, we believe there are four main areas where digital developments will drive value for pharma companies, building on what we see as the key components of digital success—an ability to deliver more personalized patient care, engage more fully with physicians and patients, use data to drive superior insight and decision making, and transform business processes to provide real-time responsiveness.
Companies do not have to become leaders in all four areas across the enterprise—some will deliver more value than others in relation to any given disease, depending on market dynamics and their portfolio. But to decide where to concentrate their efforts, they do need to develop a point of view on each area’s potential to transform their commercial and innovation models. To help in these decisions, we sketch here a picture of how we believe successful pharma companies will operate in each area in the near future.
Personalized care: Sensors and digital services for tailored, 24/7 treatment
The ability to personalize interactions with stakeholders is a key value driver from digital technology in any industry. In pharma, this value will be realized in large part through the use of sensors and digital services to provide tailored care around the clock.
Within five to seven years, a significant proportion of the pharmaceutical portfolio will create value through more than just drugs. Many drugs will be part of a digital ecosystem that constantly monitors a patient’s condition and provides feedback to the patient and other stakeholders. This ecosystem will help improve health outcomes by tailoring therapy to a patient’s clinical and lifestyle needs and enable remote monitoring by health professionals of a patient’s condition and adherence to treatment. There is already a plethora of wireless sensors on the market to measure a patient’s biophysical signals. Combining these with other data about patients as they go about their daily lives—nutritional information collected by a smart refrigerator, for instance, or exercise information from smart gym weights—will allow real-time alerts to be issued to caregivers and physicians when there is a need for intervention.
For example, a care plan for a Parkinson’s patient might include a medication regimen with “chip on a pill” technology to monitor drug taking along with a smartwatch that monitors the patient’s condition, sends him or her reminders to adhere to the prescribed treatment, and sends the neurologist compliance and health-status reports. The neurologist can then coach patients on lifestyle changes or even customize therapy remotely. Such digitally enabled approaches to patient care are likely to improve outcomes to the extent that they could become a condition of reimbursement, particularly for expensive specialty drugs.
Several companies already offer integrated products and services. WellDoc, for example, has launched BlueStar, the first FDA-approved mobile app for managing type 2 diabetes, while AliveCor has built a smartphone-based electrocardiogram. Patients take their own readings, which can be reviewed by a remote expert without the cost and delay associated with seeing a specialist. Many more of these kinds of products have recently been approved or are in development.
Medication itself will of course still be important. But it will be more personalized, targeting the needs of each patient with greater precision than before. Advanced data analytics that mine electronic medical records, including diagnostic results, medication history, and genomic, proteomic, and gene-expression data will help identify optimal therapies and predict how individual patients will respond to treatment.
Fuller engagement: Omnichannel conversations with physicians and patients
Digital-engagement technologies open up a whole new world for marketing, the exchange of information, and recruitment for trials. Pharmaceutical sales reps, medical-science liaisons, and patient-service teams can inform and influence patients, physicians, and caregivers in person or via mobile phones, the Internet, apps, or social media. Patients are already starting to use patient portals for their medical records and to communicate with their physicians, and they use apps to fill scripts and online patient communities to speak to other patients with the same disease.
Anytime-anywhere virtual care will become increasingly commonplace. Specialist virtual-care apps already exist. NeoCare Solutions, developed by Aetna, gives new parents returning home with infants from the intensive care unit on-demand coaching from a neonatal nurse. The US Department of Defense is testing robots to engage and screen soldiers for posttraumatic stress disorder,2 while in the United Kingdom, political parties are making promises to enable patients to use Skype to call their general practitioners by 2020.
All of these interactions offer pharma companies the opportunity to derive value. To realize it, they will have to build advanced digital marketing and engagement capabilities similar to those deployed by leading retailers, airlines, telecom companies, and consumer-goods companies.
Data-driven insight: Advanced analytics to increase pipeline and commercial value
Pharma companies sit on a wealth of data, usually locked away in different technical and organizational silos. Some are already linking and mining their data sets to improve their pipelines, products, and strategies. But there remains a huge opportunity to create further value from data and analytics using internal and external data sources to drive superior results. A few examples follow:
  • In R&D, digital discovery and the testing of molecules with advanced modeling and simulation techniques will be commonplace. For instance, physiological simulation will accelerate product development, and 3-D tissue modeling will help assess potential toxicity using computer simulation. In late development, sensor-data streams from in vivo clinical trials captured by wearables will be factored into registration filings and value dossiers to give an early indication of real-world effectiveness.
  • Marketing and sales forces will deploy advanced analytics to understand prescribing behavior and potential patient profiles, enabling more precise targeting of providers and increasing the number of prescriptions filed. For example, a “patient finder” technology that mines electronic medical records to identify sufferers from specific rare diseases will enable sales forces and medical science liaisons to focus on providers caring for patients likely to have those diseases, although they are as yet undiagnosed.
  • Pharma companies and other healthcare players link and analyze data from insurance claims, clinics, laboratories, sensors, apps, social media, and more in order to generate real-world evidence about a drug’s efficacy, guiding reimbursement and clinical practices. We envisage a world in which most care is “protocolized”—that is, in which clinical decisions on the best treatment options are suggested to physicians by an automated decision algorithm informed by advanced analytics. In this environment, winning pharmaceutical companies will be those able to influence the algorithm. Payors, meanwhile, will be able to develop new approaches to contracting and risk sharing for specialty drugs. Payment based on adherence or cure-rate data, or even “micropricing” based on the daily measurement of specific outcomes and quality of life, are some of the possibilities.
Real-time responsiveness: Automated processes to improve cost, reactions, and agility
Cloud and mobile technology, sensors, and next-generation business intelligence will bring about a new wave of automation in business processes—that is, streamlined, automated work flows with few handovers and end-to-end, real-time transparency on progress, costs, and business value. This will drive a step change in the efficiency, responsiveness, and agility of a wide range of complex, often cross-functional, processes, be they in the back office, the supply chain, R&D, or commercial. Banks have shown that the processing time and costs associated with opening an account or mortgage origination can be reduced by up to 99 percent and 70 percent respectively, with a clean-slate redesign of these cross-functional processes and state-of-the-art digital technology enablement.
In pharmaceuticals, employee on-boarding, sales and operations planning, launch monitoring, and marketing-content approval would especially benefit from streamlined, automated work flows and increased transparency. Clinical-trial management, from recruitment to submission, is another area that will see dramatic change with advanced automation. Targeted online recruitment and remote-monitoring technology (sensors, connected devices, and apps) will increasingly enable clinical trials to take place in “real world” settings so that patients can go about their lives with very minor changes in habits, while participating in a trial. Greatly reducing interventions in clinics or trial sites during the trial of a drug will reduce the burden on patients and make trial conditions more akin to a patient’s life when he or she is prescribed the drug outside a trial setting. Increased connectivity and automation in trial-management processes will also enable advanced trial design and monitoring approaches. For example, sites and sponsors can be connected in order to support the data management and analytics required for adaptive trial designs.

Capturing the value

Most pharma companies have started to build some digital capabilities, but talent and resources for their efforts can be fragmented, often across hundreds of small initiatives. Without clear strategic direction and strong senior sponsorship, digital initiatives often struggle to secure the funding and human resources required to reach a viable scale, and they cannot overcome barriers related to inflexible legacy IT systems. Talent and partnerships are also critical issues—many companies realize they need to form partnerships to acquire digital capabilities and specialist skills but are often unclear about what kinds of partnerships to set up and how to extract value from them.
We believe there are three strategic actions pharma companies should take to overcome these obstacles and start on a path that will capture value from digital.
  • Focus on two or three flagship initiatives. It is important to place a few big bets that will each be sponsored by a senior executive, made highly visible to the organization throughout design and pilot phases, and lauded when early wins start coming in. These flagships will need to be properly resourced from the start and supported by partnership initiatives that complement a company’s existing capabilities. The objective is to secure early success, which in turn generates the buy-in and momentum required to drive the next wave of initiatives. The choice of flagship initiatives needs to be based on a company’s pipeline, product portfolio, and business strategy. Companies should therefore identify the distinctive sources of value that digital technologies and capabilities can create in the disease areas in which they operate, and then define the flagship initiatives to develop solutions for two or three specific use cases. For example, a flagship initiative could be building a digital ecosystem (a solution combining sensors, apps, and services) for patient adherence to an upcoming oncology blockbuster launch drug (the use case).
  • Run collaborative experiments, and then scale what works. Companies cannot be expected to know in detail up front what a winning solution looks like for any particular set of assets in any particular market. For example, it is not possible for a company to design from A to Z a digital medical-affairs ecosystem on paper without experimenting with different channel platforms and content types to understand how key opinion leaders prefer to interact with the company. Hence, companies need to set up the right environment for collaborative experimentation within the initiative: for example, by putting the right people from IT, business compliance, and outside partners in a “war room” to run quick test-and-learn cycles. When results are positive—patient awareness of a disease and a particular drug increases, for instance—efforts can be scaled up. Technology prototypes can become enterprise solutions, and new ways of working become formalized and integrated into business processes.
  • Develop the organization for new business models. Digital talent may be scarce to begin with, but a digital center of excellence can help bring together what capabilities there are, concentrating them into a critical mass and avoiding duplication of resources across commercial and R&D. It can also run the portfolio of digital partnerships, ring-fence funding for digital initiatives, and codify and export learnings from pilots across markets. In this new world, it will be vital that IT evolves to be able to manage faster experimentation cycles, while still managing the legacy estate for cost and reliability. This should lead to a two-speed IT function,3 where “fast domains” operate with different skills, architecture principles, budgeting, and planning cycles to those that exist in “legacy domains” that remain focused on enterprise resource planning and traditional business applications.
We have outlined the four areas in which we believe digital will drive the most value for pharma companies. The areas leverage digital innovation to make products and services more personalized, physicians and patients more engaged, decisions and product evidence more data driven, and business processes more immediate. To capture this value, each company will need to consider how its businesses are set to be affected by the digital changes under way, and then chart its own course accordingly. A better understanding of what digital success looks like will help companies get to their destination: improved innovation and commercial models for pharma companies and better care for patients.

China’s Complexity Problem: Steve Roach

There are many moving parts in China’s daunting transition to what its leaders call a moderately well-off society. Tectonic shifts are occurring simultaneously on several fronts – the economy, financial markets, geopolitical strategy, and social policy. The ultimate test may well lie in managing the exceedingly complex interplay among these developments. Is China’s leadership up to the task, or has it bitten off too much at once?
Most Western commentators continue to over-simplify this debate, framing it in terms of the proverbial China hard-landing scenarios that have been off the mark for 20 years. In the wake of this summer’s stock-market plunge and surprising devaluation of the renminbi, the same thing is happening again. I suspect, however, that fears of an outright recession in China are vastly overblown.
While the debate about China’s near-term outlook should hardly be trivialized, the far bigger story is its economy’s solid progress on the road to rebalancing – namely, a structural shift away from manufacturing and construction activity toward services. In 2014, the services share of Chinese GDP hit 48.2%, well in excess of the combined 42.6% share of manufacturing and construction. And the gap is continuing to widen – services activity grew 8.4% year on year in the first half of 2015, far outstripping the 6.1% growth in manufacturing and construction.
Services are in many respects the infrastructure of a consumer society – in China’s case, providing the basic utilities, communications, retail outlets, health care, and finance that its emerging middle class is increasingly demanding. They are also labor-intensive: in China, services require about 30% more jobs per unit of output than do capital-intensive manufacturing and construction.
Largely for that reason, China’s employment trends have held up much better than might be expected in the face of an economic slowdown. Urban job growth averaged slightly more than 13 million in 2013-14 – well above the ten million targeted by the government. Moreover, the data from early 2015 suggest that urban hiring remains near the impressive pace of recent years – hardly the labor-market stress normally associated with economic hard landings or recessions.
Services are also the ingredient that makes China’s urbanization strategy so effective. Today, approximately 55% of China’s population lives in cities, compared to less than 20% in 1978. And the share should rise to 65-70% over the next 15 years. New and expanding cities sustain growth through services-based employment, which in turn boosts consumer purchasing power by trebling per capita income relative to that earned in the countryside.
So, despite all the handwringing over a Chinese crash, the rapid shift toward a services-based economy is tempering downside pressures in the old manufacturing-based economy. The International Monetary Fund stressed the same conclusion in its recent Article IV consultation with China, noting that labor income is now expanding as a share of GDP, and that consumption contributed slightly more than investment to GDP growth in 2014. That may seem like marginal progress, but it is actually quite rapid relative to the normally glacial pace of structural change – a process that began in China only in 2011 with the enactment of the 12th Five-Year Plan.
Alas, there is an important catch. While progress on economic rebalancing is encouraging, China has put far more on its plate: simultaneous plans to modernize the financial system, reform the currency, and address excesses in equity, debt, and property markets. Meanwhile, the authorities are also pursuing an aggressive anti-corruption campaign, a more muscular foreign policy, and a nationalistic revival couched in terms of the “China Dream.”
The interplay among these multiple objectives may prove especially daunting. For example, the confluence of deleveraging and the bursting of the equity bubble could create a self-reinforcing downward spiral in the old manufacturing economy that shakes consumer confidence and offsets the emerging dynamism of the new services economy. Similarly, military adventures in the South China Sea could damage China’s links to the rest of the world long before it is able to count on domestic demand for economic growth.
Ironically, China’s juggling act may prove even more difficult for the authorities to pull off in a market-based, consumer-oriented system. Caught in the transition from China’s tightly controlled, state-directed model, the government seems to be waffling – for example, by stressing a decisive shift to markets, only to intervene aggressively when equity prices plummet. Likewise, it is embracing more of a market-based foreign-exchange regime while guiding the renminbi lower.
Add to that a stop-start commitment to reform of state-owned enterprises and China could inadvertently find itself mired in something comparable to what Minxin Pei has long called a “trapped transition,” in which the economic-reform strategy is stymied by the lack of political will in a one-party state.
Under President Xi Jinping’s leadership, there is no lack of political will in today’s China. The challenge is to prioritize that will in a way that keeps China on the course of reform and rebalancing. Any backtracking on these fronts would lead China into the type of trap that Pei has long feared is inevitable.
Economic development has always been a daunting challenge. As warnings about the “middle-income trap” underscore, history is littered with more failures than successes in pushing beyond the per capita income threshold that China has attained. The last thing China needs is to try to balance too much on the head of a pin. Its leaders need to simplify and clarify an agenda that risks becoming too complex to manage.

The Real Message From Oil

Violent swings in oil prices are destabilizing economies and financial markets worldwide. When the oil price halved last year, from US$110 to US$55 a barrel, the cause was obvious: Saudi Arabia’s decision to increase its share of the global oil market by expanding production. But what accounts for the further plunge in oil prices in the last few weeks—to lows last seen in the immediate aftermath of the 2008 global financial crisis—and how will it affect the world economy?

The standard explanation is weak Chinese demand, with the oil-price collapse widely regarded as a portent of recession, either in China or for the global economy. But this is almost certainly wrong, even though it seems to be confirmedby the tight correlation between oil and equity markets, which have fallen sharply and which in the case of most emerging markets are back at 2009 levels.

The predictive significance of the oil price is indeed impressive, but only as a contrary indicator: Falling oil prices have never correctly predicted an economic downturn. On all recent occasions when the oil price has halved—1982-1983, 1985-1986, 1992-1993, 1997-1998, and 2001-2002— faster global growth followed. Conversely, every global recession in the past 50 years has been preceded by a sharp increase in oil prices. Most recently, the oil price almost tripled, from US$50 bbl to US$140 bbl, in the year leading up to the 2008 crash; it then plunged to US$40 bbl in the six months right before the economic recovery that started in April 2009.

A strong economic mechanism underlies the inverse correlation between oil prices and global growth. Because the world burns 34bn barrels of oil every year, a US$10 bbl fall in the oil price shifts US$340bn from oil producers to consumers. Thus, the US$60 price fall since August 2014 will redistribute more than $2trn annually to oil consumers, providing a bigger income boost than the combined US and Chinese fiscal stimulus in 2009. And because oil consumers generally spend extra income fairly quickly, while governments (which collect the bulk of global oil revenues) usually maintain public spending by borrowing or running down reserves, the net effect of lower oil prices has always been positive for global growth. According to the International Monetary Fund, the fall in oil prices this year should boost 2016 GDP by 0.5-1% globally, including growth of 0.3-0.4% in Europe, 1-1.2% in the US, and 1-2% in China.

But if growth is likely to accelerate next year in oil-consuming economies such as China, what explains plunging oil prices? The answer lies not in China’s economy and oil demand, but in Middle East geopolitics and oil supply. While Saudi production policies were clearly behind last year’s halving of the oil price, the latest plunge began on July 6, within days of the deal to lift international sanctions against Iran. The Iran nuclear deal refuted the widespread but naive assumption that geopolitics can drive oil prices in only one direction. Traders suddenly recalled that geopolitical events can increase oil supplies, not just reduce them—and that further geopolitics-driven supply boosts are likely in the years ahead.

Conditions in Libya, Russia, Venezuela, and Nigeria are so bad already that further damage to their oil output is hard to imagine. On the contrary, with so many of the world’s most productive oil regions gripped by political chaos, any sign of stabilization can quickly boost supplies. That is what happened in Iraq last year, and Iran is now taking this process to a higher level.

Once sanctions are lifted, Iran promises to double oil exports almost immediately to two million barrels daily, and then to double exports again by the end of the decade. To do this, Iran would have to boost its total output (including domestic consumption) to six million barrels per day, roughly equal to its peak production in the 1970s. Given the enormous advances in oil-extraction technology since the 1970s and the immense size of Iran’s reserves (the fourth-largest in the world, after Saudi Arabia, Russia, and Venezuela), restoring output to the levels of 40 years ago seems a modest objective.

To find buyers for all this extra oil, roughly equal to the extra output produced by the US shale revolution, Iran will have to compete fiercely not only with Saudi Arabia, but also with Iraq, Kazakhstan, Russia, and other low-cost producers. All these countries are also determined to restore their output to previous peak levels and should be able to pump more oil than they did in the 1970s and 1980s by exploiting the new production technologies pioneered in the US.

In this newly competitive environment, oil will trade like any normal commodity, with the Saudi monopoly broken and North American production costs setting a long-term price ceiling of around $50 a barrel, for the reasons explained here last January.

The Great Fall of China

ONCE the soundtrack to a financial meltdown was the yelling of traders on the floor of a financial exchange. Now it is more likely to be the wordless hum of servers in data centres, as algorithms try to match buyers with sellers. But every big sell-off is gripped by the same rampant, visceral fear. The urge to sell overwhelms the advice to stand firm. 
Stomachs are churning again after China’s stockmarket endured its biggest one-day fall since 2007; even Chinese state media called August 24th “Black Monday”. From the rand to the ringgit, emerging-market currencies slumped. Commodity prices fell into territory not seen since 1999. The contagion infected Western markets, too. Germany’s DAX index fell to more than 20% below its peak. American stocks whipsawed: General Electric was at one point down by more than 20%.
Rich-world markets have regained some of their poise. But three fears remain: that China’s economy is in deep trouble; that emerging markets are vulnerable to a full-blown crisis; and that the long rally in rich-world markets is over. Some aspects of these worries are overplayed and others are misplaced. Even so, this week’s panic contains the unnerving message that the malaise in the world economy is real.
Scoot first, ask questions later
China, where share prices continued to plunge, is the source of the contagion (see article). Around $5 trillion has been wiped off global equity markets since the yuan devalued earlier this month. That shift, allied to a string of bad economic numbers and a botched official attempt to halt the slide in Chinese bourses, has fuelled fears that the world’s second-largest economy is heading for a hard landing. Exports have been falling. The stockmarket has lost more than 40% since peaking in June, a bigger drop than the dotcom bust. 
Yet the doomsters go too far. The property market is far more important to China’s economy than the equity market is. Property fuels up to a quarter of GDP and its value underpins the banking system; in the past few months prices and transactions have both been healthier. China’s future lies with its shoppers, not its exporters, and services, incomes and consumption are resilient. If the worst happens, the central bank has plenty of room to loosen policy. After a cut in interest rates this week, the one-year rate still stands at 4.6%. The economy is slowing, but even 5% growth this year, the low end of reasonable estimates, would add more to world output than the 14% expansion China posted in 2007.
China is not in crisis. However, its ability to evolve smoothly from a command to a market economy is in question as never before. China’s policymakers used to bask in a reputation for competence that put clay-footed Western bureaucrats to shame. This has suffered in the wake of their botched—and sporadic—efforts to stop shares from sagging. Worse, plans for reform may fall victim to the government’s fear of giving markets free rein. The party wants to make state-owned firms more efficient, but not to expose them to the full blast of competition. It would like to give the yuan more freedom, but frets that a weakening currency will spur capital flight. It thinks local governments should be more disciplined but, motivated by the need for growth, funnels credit their way.
Fears over China are feeding the second worry—that emerging markets could be about to suffer a rerun of the Asian financial crisis of 1997-98. Similarities exist: notably an exodus of capital out of emerging markets because of the prospect of tighter monetary policy in America. But the lessons of the Asian crisis were well learned. Many currencies are no longer tethered but float freely. Most countries in Asia sit on large foreign-exchange reserves and current-account surpluses. Their banking systems rely less on foreign creditors than they did.
If that concern is exaggerated, others are not. A slowing China has dragged down emerging markets, like Brazil, Indonesia and Zambia, that came to depend on shovelling iron ore, coal and copper its way (agricultural exporters are in better shape). From now on, more of the demand that China creates will come from services—and be satisfied at home. The supply glut will weigh on commodity prices for other reasons, too. Oil’s descent, for instance, also reflects the extra output of Saudi Arabia and the resilience of American shale producers. Sliding currencies are adding to the burden on emerging-market firms with local-currency revenues and dollar-denominated debt. More fundamentally, emerging-market growth has been slowing since 2010. Countries from Brazil and Russia have squandered the chance to enact productivity-enhancing reforms and are suffering. So has India, which could yet pay a high price.
The rich world has the least to fear from a Chinese slowdown. American exports to China accounted for less than 1% of GDP last year. But it is hardly immune. Germany, the European Union’s economic engine, exports more to China than any other member state does. Share prices are vulnerable because the biggest firms are global: of the S&P 500’s sales in 2014, 48% were abroad, and the dollar is rising against trading-partner currencies. In addition, the bull market has lasted since 2009 and price-earnings ratios exceed long-run averages. A savage fall in shares would spill into the real economy.
Ageing bull
Were that to happen, this week has underlined how little room Western policymakers have to stimulate their economies. The Federal Reserve would be wrong to raise rates in September, as it has unwisely led markets to expect. Other central banks have responsibilities, too. Money sloshing out of emerging markets may try to find its way to American consumers, leading to rising household borrowing and dangerous—and familiar—distortions in the economy. So Europe and Japan should loosen further to stimulate demand.
Monetary policy is just the start. The harder task, in the West and beyond, is to raise productivity. Plentiful credit and relentless Chinese expansion kept the world ticking over for years. Now growth depends on governments taking hard decisions on everything from financial reforms to infrastructure spending. That is the harsh lesson from China’s panic.

Germany’s demographics: Young people wanted

When the quiet village of Ottenstein, in northern Germany, was faced with its school closing for lack of children, Manfred Weiner, its mayor, hit upon a novel way of attracting young families.
Instead of renting out village land to farmers, he is giving it away for free to people willing to move to the picturesque hamlet. Successful applicants will be awarded a building plot on one condition: that they have young children and, preferably, intend to have more. 

About 30 couples have responded. The newcomers will not on their own rejuvenate Ottenstein’s ageing population of 900. But they could be enough to save the school, which the authorities have pledged to keep open as long as the roll does not drop below today’s level of 50. “We have to keep the school,” says 71-year-old Mr Weiner. “What is a village without a school? Without a baker? Without a butcher? Without a pub?”
Across Germany, other mayors are asking themselves the same questions. Despite a surge of immigrants — Germany expects 800,000 asylum seekers this year — the population is set to decline from a 2002 peak of 82m to 74.5m by 2050, according to the UN. The percentage of Germans under 15 is forecast to fall to 13 per cent, among the world’s lowest. The share of those over 60 is expected to rise from 27 per cent to 39 per cent.
Immigration will change the ethnic mix, but migrants who settle in Germany are likely to follow the pattern set by native Germans, who raise too few children to replace earlier generations. “Demographic change is one of our great challenges,” said Wolfgang Schäuble, finance minister, this year.
While many EU countries face similar strains, Germany’s are particularly acute. With a strong economy and low unemployment, its working-age population is falling, putting huge pressures on employers. And there are also possible geopolitical consequences: with the British and French populations set to grow, Germany may not remain the EU’s most populous country — or even its biggest economy after 2050, with implications for Europe’s balance of power.
Yet, as a rich country with a highly- educated population, Germany has the opportunity to become an innovator in how to manage an ageing population. “Demographic change need not be a catastrophe. The question is how to react,” says Reiner Klingholz, director of the Institute for Population and Development. “Governments are all used to managing growth. They must now learn how to manage shrinkage. We need a complete rethink in our societies.”
The problem is ageing societies are not necessarily good at rethinking. While many older people express concerns about society at large, when it comes to politics, they tend to care a lot about themselves and their pensions. Governments pander to their demands: Chancellor Angela Merkel’s biggest spending handout has been cutting the minimum retirement age to 63 for long-service workers and raising pensions for non-working mothers. Mr Klingholz says: “This kind of behaviour might get worse.”
Germany’s demographic challenge stems from its low birth rate. Post-1945, West German governments stuck to the view that women should care for children at home and offered less state-backed childcare and other support for working mothers than in France or the UK. Faced with the choice between a job and children, many German women chose their jobs.
Since German reunification in 1990, the authorities have tried to catch up, notably by expanding kindergartens, but are struggling in the face of the popularity of the childless lifestyle. The fertility rate is at 1.4 children per woman, compared with 2 (the replacement rate) in France, 1.8 in the UK and an EU average of 1.6. Deutsche Bank says in a report: “Despite massive investment in family policy the fertility rate has never risen . . . by any significant measure.”
With fewer children born, Germany is rapidly going grey: at 46, the average age is second only to Japan’s. Already one in 20 Germans is over 80. By 2050 it will be one in six, on UN data.
The strains are exacerbated by domestic shifts. Decades after young British and French people fled small towns for urban areas, young Germans are being lured by the excitement of big cities. This process was long held back by Germany’s decentralised structure, which encouraged people to stay in their home regions, and by the proliferation of smaller family-owned companies offering high-quality apprenticeships, even in unfashionable places.
But fuelled by cheaper travel, young Germans have grown restless and come to prefer university over factory training. So while the overall population has fallen slightly since 2000, the combined total for the largest cities — Berlin, Munich, Hamburg, Cologne and Frankfurt — has grown nearly 10 per cent.
Compounding these movements is the westward shift of 2m east Germans after the 1989 fall of the Berlin Wall in pursuit of jobs. If east Germany were still a separate country it would have the world’s oldest population, with an average age of over 47.
But the ex-GDR is not alone, as Ottenstein shows. The surrounding district’s population has dropped nearly 15 per cent in the past 20 years and is forecast to drop by a further 15 per cent in the next 10 years. There is no shortage of jobs, but young people prefer to live in nearby cities, such as Hannover. Mr Weiner, the mayor, denies his family recruitment campaign comes at other villages’ expense. However, a federal government official says: “Of course, there is growing competition between communities for people. Localities have to compete, not just with jobs but with the attractiveness of their town or village.”
The immigration wave — the result of crises in the Middle East and Africa — has halted the national population decline, with net inflows of migrants of more than 400,000 annually in the past two years, up from a recent yearly average of just 100,000. The net inflow will almost certainly rise this year.

Immigration is not enough

But Berlin assumes this wave is temporary. And it calculates that even if the average long-term net inflow rises to 200,000 a year, the population will still decline. Such a sustained increase is seen as unlikely because UN forecasts show eastern European states, which have long been Germany’s largest immigration reservoirs, are themselves facing population drops. Meanwhile, many Germans fear immigrants from further afield, such as asylum seekers from north Africa and the Middle East, may prove harder to integrate into society.
For employers, the most immediate challenge is a growing skilled labour shortage. With unemployment at only 6 per cent, the market has little slack — and as the baby-boom generation retires, it will only tighten further. Prognos, a research institute, calculates companies will be short of 1.8m skilled workers by 2020, and 3.9m by 2040.
Immigrants, often recruited directly from abroad, are filling some gaps. Markus Kerber, managing director of the BDI, the employers’ association, says: “More people than ever are learning German, all over the world, because of the attractions of working and living in Germany.” But immigration is not enough to end the skilled worker shortage that translates into about 350,000 a year — nearly as much as the net inflow of all immigrants.

Wooing the older voter

This makes it more important that working-age people work. After years of lagging Britain and France, Germany has almost caught up in terms of female participation in the labour force, with 54 per cent of working-age women in employment compared with 43 per cent in 1990. For workers aged 60-64, the result has been even more dramatic, with the employment ratio rising since 2008 from 28 per cent to 50 per cent. Siemens, the electronics group, says this has been largely done by offering extra training, flexible working, and opportunities to work from home.

“Any deviation from the gradual increase of the legal retirement age to 67 by 2030 . . . would be counterproductive,” Deutsche Bank said in a recent report. Without dramatic changes, Mr Kerber predicts that companies will look outside Germany for workers. Twenty years ago, the focus was on eastern Europe, followed by China and other emerging countries. Today, companies are looking again at the US — not least because of its growing labour force.Employers hope that a steady rise in the retirement age from 65 to 67 will extend working lives, especially with the spread of minijobs — flexible-contract posts — that appeal to older workers. But there is a fly in the ointment: Ms Merkel’s “retirement at 63” law.

If fewer Germans work, it will be difficult to maintain gross domestic product growth even at the current long-term rate of 1.2 per cent. Pensions and heathcare costs are expected to grow more rapidly, increasing the burden on a shrinking working population. The European Commission forecast this year that the total cost of the elderly would rise in Germany from 19 per cent of GDP in 2013 to 23.8 per cent in 2060, assuming economic growth of 1 per cent. Germany’s costs are expected to rise more than the EU average due to rapid ageing and generous pensions.
In response, the government is raising the official retirement age and encouraging individuals to save. Berlin has also cut the fiscal deficit to zero even as most eurozone governments are deep in the red. The aim is to cut public borrowing from nearly 80 per cent of GDP to less than 70 per cent. As a finance ministry official says: “With the population getting older, it makes it even more important that we avoid new debts.”
But it may need to do more, especially when it comes to promoting later retirement. “Germany will still have to make considerable changes if economic momentum and wealth are to be safeguarded or even increased over the coming decades,” Deutsche Bank says.
However, few old people like change, and old people have a disproportionate voice in German politics. In the 2013 parliamentary election, 36 per cent of voters were aged 60 or over, well above their 27 per cent share in the population. “The dependence on the 60-plus vote is growing bigger,” says Mr Klingholz. “The problem is not that they don’t care about the younger generations. The problem is that the politicians woo them with promises.”
However, others suggest greying voters are not so easily bought with handouts. Manfred Gullner, of the Forsa polling agency, says today’s 60- and 70-year-olds helped launch Germany’s powerful Green movement and backed the clean energy revolution. “Older people are not necessarily less progressive.”
The mayor of Ottenstein agrees: “At first the old people in the village, they didn’t want to give our land away. But they wanted the village to have a future, even once they have gone. So they supported the scheme.”

Welcome to a wild world of robot investing

This week’s turbulence in the markets was not just a reminder of the ever -growing importance of China’s economy; it was also testimony to how computers dominate the workings of the west’s stock exchanges.
Never mind that the Dow Jones index plunged by 1,000 points in just a few minutes on Monday morning (before later rallying). What was more startling was that the share price of stalwart American companies such as AppleHome Depot or General Electric gyrated even more dramatically in minutes. * Meanwhile, the value of some exchange traded funds tumbled more than 30 per cent. So much for the idea that such funds are boring. 

While it may take weeks before regulators understand why the plunges occurred, one reason for the swing is that automated computer programs have changed how markets function. The use of similar programs — such as high-frequency trading strategies — has expanded so rapidly that these are now estimated by the Securities and Exchange Commission to represent more than half of all US stock trades, and a big chunk of other asset markets.
Orders are being executed at lightning speeds in huge volumes. But there is another, often overlooked implication: these machines are being programmed to link numerous market segments together into trading strategies. So when computer programs cannot buy or sell assets in one segment of the market, they will rush into another, hunting for liquidity.
Since their algorithms are often similar (or created by computer scientists with the same training) this pattern tends to create a “herding” effect. If a circuit breaks in one market segment, it can ripple across the system faster than the human mind can process. This is a world prone to computer stampedes.
Machines are being programmed to link numerous market segments together into trading strategies
Some financiers insist this does not matter. Financial history amply shows that panic selling often occurs with humans too (the US stock market lost almost 90 per cent of its value in the three years after the 1929 crash). The good news about 21st-century computer stampedes is that while they are violent, they tend to be shortlived. By Tuesday the price gyrations seen on Monday had largely died down; similar recent wild bursts of volatility in bond markets also vanished fairly rapidly.
But the bad news is that when these computer stampedes do occur, small players and retail investors tend to suffer most. We do not yet know precisely who lost and gained most this week. But Douglas Cifu, head of Virtu, the world’s largest high-frequency trader, has revealed that Monday was one of the most lucrative days his firm has ever seen; other high-frequency traders have echoed this. Conversely, many of the investors who were trying to sell exchange traded funds at tumbling prices via their brokers on Monday were almost certainly retail players.

There are no easy solutions. In the past, banks smoothed trading flows by acting as market makers. But they have partly withdrawn from that role due to a regulatory squeeze. And nobody seems ready to kick computing trading programs out of the market, since in normal times they appear to provide the liquidity that banks no longer offer. Without high-frequency traders it would probably be more costly for investors of all sizes to trade.Little wonder that Jim Cramer, the CNBC television host who is popular with small investors, presented his show on Monday under the tag “Rage Against the Machine”; nor that Michael Lewis’s critical book about high-frequency traders was a best seller last year. For many western investors, this week’s events showed there is a yawning inequality in modern markets.

In response, policymakers are now trying to make algorithmic trading more transparent and robust. After a market “flash crash” in 2010, the New York Stock Exchange introduced new circuit breakers, which temporarily stop trading when stocks gyrate too much. While these can sometimes calm markets, on Monday they may have created more panic: one reason the prices of exchange traded funds swung so bizarrely was that there were no prices available for the underlying stocks.
The result is that policymakers — and investors — are in a bind. Nobody wants to get rid of the robots — just this week BlackRock announced that it was purchasing a so-called “roboadviser”, to tap into swelling consumer demand for automated portfolio management. But nobody quite understands what the robots are doing to markets, let alone trusts them. What is crystal clear is that wild gyrations of the sort seen this week are now a central feature of our modern, robot-dominated markets. Human investors, stand warned.

Friday, August 28, 2015

Luxury faces tough quest for next big market

With demand slowing and a weaker yuan, face less fashionable growth. Since the currency's surprise devaluation on August 11, shares of brands likeand who rely heavily on China's bauble-hunters have fallen 13 per cent and 14 per cent respectively. Finding the right mix of scale, rising incomes and inequality for luxury's next hotspot will be tricky.

China has gone from a blip on luxury's radar 15 years ago to the source of a third of global sales. Burberry's 2002 annual report gave the country just two passing references. Today it gets 40 per cent of its revenue from Chinese shoppers and has 17 stores in Hong Kong alone.

The conditions for a luxury growth story are pretty specific. China for years had lively gross domestic product growth (GDP), peaking at 14 per cent in 2007, huge scale and a pool of ultra-high net worth spenders chased by a growing, covetous middle class. Urbanisation promoted the status hunger that drives luxury purchases. China's city dwellers grew from 31 per cent of the population in 1999 to 54 per cent today.

India has many of the same conditions. It has the world's fourth-largest billionaire populace, and similar growth rates to China. But low per-capita and poor retail infrastructure have kept Western brands away. Louis Vuitton's website lists only four stores in India. Just 32 per cent of Indians live in cities.

Brazil has also lost appeal as its currency has fallen in value. Sliding commodity prices have hit economic growth and the weakening real means spendthrift Brazilian tourists have lost spending power. Other emerging markets are years from matching China's heft. Nigeria has wealth but poor infrastructure. Kazakhstan has inequality, but a falling oil price means one store is already enough.

The most promising market might not be emerging but re-emerging. Consumption of luxury in the United States is set to grow one to three per cent in real terms in 2015, says Bain. That's better than the two to four per cent decline forecast for China. True, real wage growth for US workers was just 2.1 per cent year-on-year in July.

But there is a strong case for luxury goods companies to hunt closer to home.