An alternative to US Treasuries?

The European Union has just issued the first bonds under its (AAA rated) EUR900 billion Recovery Fund – known as SURE bonds – to provide coronavirus relief to European Union nations.

10 year and 20 year bonds were offered. EUR10 billion of the 10 year bond and EUR7 billion of the 20 year bond were issued, at yields of -0.238% and 0.131% respectively. Demand was exceptionally strong. EUR233 billion of bids were received, more than 13 times the amount of bonds issued.

Significantly, 37% of the 10 year bond and 13% of the 20 year bond were taken up by central banks. Part of the attraction of these bonds was their yield advantage over the equivalent German Bunds (36.7 basis points and 52.1 basis points respectively). However, the yields on these new SURE bonds were well below those of equivalent US Treasury bonds.

Clearly, investors are eager for an alternative to US Treasuries. Investor demand for lower yielding European sovereign bonds and the recent reduction in China’s official holdings of US Treasuries and its increase in holdings of Japanese Government Bonds are two prominent examples of this search.

The SURE bonds’ auction result also signals a vote of confidence in the Eurozone and EUR as a global reserve asset. This comes at a time when not only is the US dollar’s dominant role being questioned for economic, political and fiscal reasons, but also central banks and institutional investors are seeking an alternative (to the US) for their safe haven and reserve investments.

Is Trump facing his own Falklands moment?

In early 1982, the UK Prime Minister, Margaret Thatcher’s position and her political future were under threat. She faced sharp criticism from within her government and the public following savage government spending cuts, a declining manufacturing industry and high unemployment. Then, the Argentinian military invaded the Falkland Islands, a remote and disputed UK protectorate in the South Atlantic.

Against the advice of many in her government, many of her close advisors and then US President, Ronald Reagan, Thatcher ordered a formidable military response to the Argentinian invasion of a British territory. The UK was victorious after six weeks of deadly and widely media-covered conflict that resulted in considerable casualties and large material losses on both sides but a surge in Thatcher’s popularity. Some even saw her actions as putting the ‘Great’ back into Great Britain.

Margaret Thatcher remained UK Prime Minister until 1990, making her the UK’s longest serving prime minister in the 20th century.

US President, Donald Trump, is facing sharp criticism and loss of popularity because of many domestic issues, notably for his response to the coronavirus pandemic and the uninspiring US economic and jobs recovery from the pandemic’s initial shock. Importantly for Trump, he is a long way behind his Democrat opponent in the opinion polls with the presidential election less than four months away.

Trump is blaming many others for his domestic failings and falling popularity, and is taking pot shots at China on a number of issues, most recently the Hong Kong National Security Law, territorial disputes South China Sea, Huawei and a longstanding trade imbalance.

In recent days, US Secretary of State Mike Pompeo, has ramped up the US rhetoric about the territorial disputes in the South China Sea between China and (non-US) nations who, nevertheless are US allies.

Trump is vulnerable to his own Falklands moment. This time the player is mightier (militarily and economically) and the stakes for the world much higher than in 1982.

The global reach and importance of the Big Three

The US is the world’s biggest economy and third most populous nation. China is the world’s second biggest economy and most populous nation. India is the world’s second most populous nation. Their economic, social, military and political activities have global significance, especially as each fights for its own perceived geopolitical importance.

The US, China and India have much in common in how they view and aspire to their respective national interests. How they behave internally and with each other have the potential to disrupt other nations and risk a world littered with geopolitical collateral damage.

Adding layers of complexity to the inter-actions and relationships between the US, China and India are their political constraints and political drivers (and personalities) of their respective leaders. The US and India have populist incumbent elected leaders who are very aware of, perform to and frame policy around their respective election cycles. China’s leader not only wears none of those labels but can (and does) frame long term policy without the restriction of election cycles.

In many areas of geopolitical influence, the US is in decline (not surprising given its isolationist trade policies in response to globalisation). It is resisting (or in denial of) that decline and its waning global geopolitical dominance, and fighting off its perceived challengers.

China is slowly catching up to or, in some cases overtaking, the US in its global economic, military and geopolitical influences, much to the frustration of the US.

The COVID-19 pandemic has added a layer of complexity to the direct relationships between and influences of the US, China and India. The coronavirus pandemic hurt China initially but China rebounded quickly. The US and India lag China in their efforts to contain COVID-19 and return their respective economies and global geopolitical standings to their pre-COVID positions – much of that lag and their sluggish and haphazard response to the pandemic can be laid at the feet of their populist leaders.

India has always taken a more introspective approach with international relations, compared to the US and China, but has always been assertive when it comes to its borders, especially those with Pakistan and China. Equally, China is also asserting itself with its borders, territories (currently focused on Hong Kong) and shipping lanes (currently focused on the South China Sea) while the US is shoring up its border with Mexico.

The US and China, in their battle to be the world’s number one in terms of economic, military and geopolitical influence, are seeking partners and allies. Other nations that take sides in such a battle will only increase the list of collateral casualties and further hamper the global recovery from the damaging effects of the COVID-19 pandemic. As difficult as it will be, not taking sides between the US and China will prove to be a nation’s strategy for survival.

Never poke an eagle or a (panda) bear

An increasingly relevant sideshow to the effects of, fight against and recovery from the COVID-19 pandemic is the November US Presidential election. Donald Trump has begun his re-election campaign using many of the same themes and ‘tools’ that got him elected in 2016, mainly bluster, bullying (anyone who disagrees with or argues against him), isolationism and consistent selection and redefining of facts and the truth. As a result, the US is facing the erosion of its status as the global superpower.

China seems to be taking the opportunity presented by Trump’s bluster, poor judgement, lack of leadership and isolationist moves to fill the global leadership gap left by the US, to show the world that China is the equal of (or greater than) the US as a global superpower and to tidy up what it sees as domestic matters. The World Health Organisation is just one battlefield between the US and China.

China is quietly but assertively absorbing the Trump Administration’s anti-China vitriol. At the same time, it is escalating the addressing of longstanding domestic matters, such as the integration of Hong Kong into the People’s Republic of China, the security of shipping lanes in the South China Sea (the recent sinking of a Vietnamese fishing boat), the security of its land borders (the escalating stand off on the India-China border) and the safety of its citizens overseas (China’s actions in response to the extradition proceedings of the Huawei CFO who is also the daughter of its founder).

The US and China, in attacking each other and the other’s perceived allies, in their battle to be the world’s biggest geopolitical influencer, risk spreading their animosity throughout the world. Rising tensions between the US and China have the potential to inflame and divide the world, with serious geopolitical, economic and military consequences for everyone, more so in this fragile coronavirus period.

Desperate borrowers and stupid investors

Is one investor’s junk (bond) someone else’s treasure? Hardly. There is no point in earning a high return or yield on your investment if you lose all of your capital.

US and European credit markets have been hives of intense, record-breaking activity since late March as lesser rated borrowers rushed to build cash reserves ahead of expected troubled times and investors sought higher returns compared to the low returns from higher rated borrowers and the extremely low (or negative in some cases) returns from the traditional safe haven of government bonds.

Travel bans in US, Europe and UK suddenly halted the income for businesses in tourism and hospitality, such as airlines, cruise lines, hotels and resorts, rental car companies and airport owners/operators. The spread of coronavirus and subsequent lockdowns of businesses and households in the US, Europe and UK not only exacerbated the situation of those in tourism and hospitality but also spread the cessation of income to other sectors.

In such sudden and dire circumstances, it is no surprise that credit margins rose dramatically because borrowers rushed to issue debt (rightly so to create funds for future debt obligations and cash flow requirements) and investors demanded higher returns (rightly so because of higher systemic, industry and borrower specific risks). In other words, the so-called free market adjusted the rewards to counter the greater risks.

What is a surprise is the eagerness of many investors to buy the debt of (invest in) companies with very limited, or close to no, income projected for the next three to six months and in industries that have all but collapsed in the wake of the COVID-19 pandemic, i.e. businesses with very high default risks.

The cruise line Carnival issued USD4 billion in bonds backed by 86 of its cruise ships and intellectual property. Norwegian Cruise Line issued USD675 million of bonds at a yield of 12.575% secured by islands it owns in the Bahamas and Belize. Delta Air Lines issued USD5 billion of bonds and loans backed by landing rights and routes. What would all this collateral be worth in the event of bankruptcy, especially if the cause is systemic?

Debt raised by a number of US airlines, rental car companies and cruise lines have been issued at eye-watering margins and eagerly snapped up by investors. Yet, investors bought bonds issued by Avis even though Hertz went agonizingly close to filing for bankruptcy (for now) and airlines continue to issue bonds even after United Airlines pulled its proposed bond offering because investors balked at the (weak) collateral security offered.

Can someone tell me who these investors are?

Is the collapse in car sales the canary in the coal mine for the US economy?

Trends in car sales are a significant indicator of economic activity in all but some emerging market economies because of their linkage to household confidence and spending. For example, the growth in car sales in China have accompanied that country’s recent economic rise. China recently overtook the US as the world’s largest car market and is on track to overtake the US to become the world’s biggest economy.

Just released data on US car (auto) sales in April makes alarming, but not surprising, reading. Compared to April last year, US auto sales for Toyota were 54% lower, Subaru’s sales were 47% lower, Mazda’s were 44% lower, Hyundai’s were 39% lower and Kia’s 38% lower. Others, notably GM, Ford and Volkswagen, release sales figures quarterly, so their official numbers for April are not available although their sales for the March quarter were down by slightly less than the above-listed manufacturers and forecasts are for sales in May and June to be just as dire as in April.

This begs the questions – are US car sales and prices going down the same path as the US oil market went in April and what does that mean for the US?

Both US auto and oil markets have suffered a sudden drop in consumption and sales because of the responses by businesses, households and (State and Federal) governments to the COVID-19 outbreak in the US. Both have run into storage problems and costs because of the product pipeline, which is more alarming for the car industry because of its ‘just in time’ inventory management. Car (auto) manufacturing has collapsed to a trickle in the US, China, Japan and Europe.

A number of US oil production, drilling, exploration and supplier companies, led by the more vulnerable and leveraged, have folded or are staring down the barrel of bankruptcy. Given the expected drastic contractions in US economic growth, employment, business investment and household spending, I have two questions:
– are car prices in the US (and, by association, the rest of the world) heading down the same path as oil prices?
– are auto manufacturers in the US heading down the same path as companies in the US oil industry?

An affirmative answer to both questions will have severe explicit and implicit implications for households, businesses, governments, economies and future generations in the US and around the world.

A viable alternative to investing in the US

The European Union (EU) is discussing plans to issue pan-European sovereign debt to centralise the work being done by respective EU members’ central banks. The EU Recovery Fund (the Fund) will effectively monetise EU governments’ borrowings used to fund fiscal spending to combat the COVID-19 pandemic.

The plan is for the Fund to be of a sufficient magnitude so it can support the most affected EU sectors and geographical parts and avoid a prolonged 1930s style depression. The proposal is to gear up the Fund to create a borrowing programme of at least EUR1 trillion.

As with any decision by the EU, there is considerable debate over how the fund should operate, in particular whether it should provide loans or grants. The hardest hit countries such as Italy and Spain would like to receive the assistance as grants, or direct money transfers, but the more fiscally disciplined members such as the Netherlands, Austria and Germany seemingly prefer loans, albeit it at low interest rates. Either way, the Fund will borrow from financial markets for its assistance to member nations.

Almost all media reporting and comment has been on political debate within the EU, and on the form and amount of assistance to troubled EU members. I have not seen any comment on the Fund’s borrowing programme despite its immense implications for financial markets. It seems logical that the Fund will offer debt that is guaranteed joint and severally by all EU members. That would put the Fund’s debt on par with US Government debt, as a risk free sovereign guaranteed investment.

The key attraction of US Government debt has been as a risk free investment in the world’s reserve and trade currency. Investors, especially sovereign nations through their central bank or wealth funds wanting to diversify away from US Government debt, lack an alternative liquid, plentiful prime risk-free investment.

The gap between the yield on 10 year US Treasuries and German bunds is more than 100 basis points (1.00%), which is at odds with US Treasuries’ status as the world’s prime risk free investment because investors are demanding a 1.00% higher return from US Government bonds compared to German Government bonds over the next 10 years.

The Fund could provide a powerful alternative, especially if the world decides that the yields offered by US Government debt no longer compensates for the US’ risk.

Given the current strained relationship between China and the US, notably on matters of trade and coronavirus, the US should be worried that one of the largest holders of US Government debt could be tempted to put a chunk of its money somewhere else. Especially if that somewhere else is of equal risk and geopolitical importance. Where China’s money goes, others will follow.

What changes to our work-life balance can we expect after COVID-19

COVID-19 is having a drastic effect on people (especially the sick and vulnerable), healthcare systems and economies. It has forced changes to how we think and live now, and will change how we think and live in future. It has also caused businesses to assess their core values and assets. Hopefully, they conclude that the latter are their people.

Some changes will be temporary.

Some changes will linger and re-shape how we work, live and play in the future.

Some changes will be positive.

Some changes will be negative.

Some changes will introduce new fears and prejudices and re-shape generations’ view on life, as happened after the 1929 crash, the 1987 crash and the 2008/09 Global Financial Crisis.

Many changes will take years to materialise or become apparent.

One example of change is that many New Zealanders, because the country is in full lockdown, have been forced to work from home. This has resulted in some compromises to work productivity, family dynamics and work-life balances, in elevated stress levels and in new approaches to old problems.

Prior to the coronavirus outbreak, many New Zealand businesses did not allow staff to work from home, or discouraged staff from working from home because many business managers considered working from home to be unproductive or inefficient or just an excuse to skive off.

Under full lockdown, many New Zealand businesses not only have had to accommodate staff working from home but also have had to facilitate it, support it and adjust for it. In the process, weaknesses in WiFi and broadband coverage and speed have been exposed.

The majority of businesses’ previous objections to reservations about staff working from home have proven to be erroneous, or the product of businesses managers’ prejudices or the desire to wield control over subordinates or another example of many business managers’ incompetence, lack of imagination or inability to think laterally.

Solutions to weaknesses in WiFi and broadband coverage must be found (more cell towers and more fibre optic cables perhaps?). Two arguably important and influential politicians in New Zealand, Simon Bridges (Leader of the Opposition) and Phil Goff (Mayor of Auckland), have been without adequate internet service in their homes. Their circumstances may be the trigger for improving internet services.

The recent and unplanned change to New Zealand’s business environment and work-life balance need not be temporary. It is an opportunity to try a different approach to the work-life-home balance, to try to do something different (and better).

Sure, there are a number of businesses that will always require face to face interaction between the business and its customers, such as in the tourism and hospitality industries, and hairdressing. The retail sector has been undergoing an evolutionary change in recent years with the rise in on-line shopping. COVID-19 has forced tourism and hospitality sectors into a revolutionary change, but there is only so much that can be done.

It is imperative that economies dependent on international tourism, such as New Zealand, Pacific Islands, the Caribbean must find alternative sources of lost export earnings.

A positive from COVID-19 has been environmental benefits, specifically clean air (especially in smog-ridden cities such as Beijing, Shanghai, Delhi and Mumbai) and clean waters (Venice). Air and water pollution are unwanted consequences of industrialisation and, to some extent, globalisation. The world has seen clean air and water in places where they have not been seen for decades but the newly clean air and water have been at the cost of economic activity and jobs.

It may take years for businesses, workers and governments to recover from the effects of, responses to and consequences of COVID-19. The environment though will take a very short time to return to its previous polluted state unless action is taken now. But I doubt there will be any actions to improve the environment will be as timely and extensive as those to restore economic growth and jobs in industrialised nations.

The tourism and hospitality sectors, among others, and their influences on and contribution to the New Zealand economy may never be anything like they were before COVID-19. Equally, this is an opportunity to examine not only how and why businesses operate but also the businesses’ and societies’ core values, assets and long term goals. This applies to all industries and in all countries.

US and India – twins by another mother

A nation and its people are judged by how the weakest are treated. To quote Pearl S Buck – “the test of a civilisation is the way that it cares for its helpless members.”

COVID-19 has shown itself to be capable of spreading virulently, irrespective of differences in societies and people. It ruthlessly attacks most often where a predisposition or weakness exists, i.e. through genetic, health or social circumstances, which brings into stark relief the similarities and differences between many nations’ healthcare and political systems.

A critical factor in each nation’s response is how its health system treats the poorest, weakest and most socially outcast because a nation’s health system gives an insight into that nation’s sense of equality, justice and fairness, as well as an insight into its social principles, political establishment and economic strength.

The US is the world’s biggest economy and democracy in GDP terms (the definition of which is a topic for another day) and the world’s biggest creditor nation. Yet it has a health system that, in many ways, resembles that of a third world or developing nation. It is a world leader in many areas of healthcare technology, but its healthcare is available only to those with expensive insurance, i.e. the wealthy and middle class. Those at the bottom of the socio-economic scale miss out, as the COVID-19 pandemic is showing. India is the world’s biggest democracy on a population basis and has health and political systems that behave much like that of the US.

The US has a big gap between the very rich and the rest, and between the middle class and those at the bottom of the socio-economic ladder. India is the same.

Religion (Christianity) has a strong hold in the US and yet there is harsh racism directed at lower socioeconomic classes, many of whom are descendants of former slaves. India is the same, with Hinduism and the caste system. Furthermore, both the US and India display an irreligious prejudice to those of the Muslim faith.

US politics, at both Legislative and Executive branches and at federal and state levels, are deeply polarised by seemingly irreparable partisan divisions. At its political head is a populist who exploits public fear and ignorance to build popular support and who revels in the media spotlight. India is the same.

COVID-19 has shown that the US and India have too much bureaucracy and no communication or co-operation between federal and state government levels.

The President of the US wants to move the country towards self-sufficiency in terms of its global political and trade relationships. India is the same.

The US relies on the world’s investors to fund its federal budget deficits and years of profligate government spending. India is similar although the numbers are smaller.

The various arms of the US federal and state governments and its public service have not been united in fighting the COVID-19 pandemic. Consequently, the US now has the greatest number of COVID-19 related deaths, is experiencing an economic fallout that is unfolding at an unprecedented pace and extent and, in many circles, is debating the wisdom of going it alone in a bid to ‘make America great’.

A majority of Americans would be appalled to consider themselves as having more in common with India than with other industrialised nations. India has four times the population of the US in a third of the land mass. Let’s hope that India does not go down the same deadly COVID-19 path as the US.

Be careful what you wish for, Mr Trump

US President, Donald Trump, has become another in a long line of US Presidents to push the US towards isolationism. In his Farewell Speech, the first US President, George Washington, warned against “entanglements” against other nations and permanent foreign alliances. Washington was warning against Europe. Trump has specifically targeted China although he has also roiled against Europe, Japan, Canada and Mexico, among others, which hints strongly that he desires full US isolationism from the world.

Be careful what you wish for Mr Trump. Successful US isolationism might look fine from inside the US bubble but it looks very different from the outside looking in. The US would be alone in the world. Yet, the US has never been fully self-supporting and is even less likely to be so now.

Lionel Shriver’s 2016 novel, The Mandibles, depicts the descent of the US from superpower to global pariah that results in the destruction of all the US’ social, health, fiscal, economic and financial structures. The trigger in the novel is the US’ insistence of its right for the world to eternally buy its ever-growing, massive debt at favourable interest rates to fund its ballooning budget deficits at affordable costs. There is no explicit suggestion in Shriver’s novel of the US adopting isolationist policies. It does not take much to imagine the world very quickly losing its desire to fund the US’ fiscal excesses if the US decides to go it alone.

We are seeing worrying signs of Donald Trump’s desire to put America first in the battle against COVID-19 with little or no regard for the welfare of and the US’ long term relationships (trade and fiscal) with those outside the US. Trump and the US might win some external battles in the fight against COVID-19 but Trump could lose his isolationist war that would result in the US not being “Great’ but becoming insignificant.