African Extractive Industries: PRC Neocolonialism

♠ Posted by Emmanuel in ,, at 5/30/2024 01:12:00 PM

That the slow development of the African continent can be traced to Western colonialism is an archetype of this field of study: Mainly interested in extracting natural resources for manufacturing industries sited elsewhere (e.g., Europe), foreigners have come for valuable minerals... and not much more. It would be neat if this story was confined to the history books, but we keep being reminded that it is instead very much a story of the 21st century still. 

Of note in this respect are the Chinese. The stereotype of Chinese industrialists enticing corrupt regimes all over the continent with easy money in exchange for mineral access is a story told over and over. Stung by this criticism, the PRC decided to change tack in characterizing their activities as developmental win-win situations: In exchange for being granted access to mineral resources, the Chinese would help improve the infrastructure of the countries they operated in to accommodate the influx of wealth brought by extractive industries. That is, improved ports, roads, power stations and so forth would better facilitate trade and development for all concerned. Well, that was supposed to be the story of the Belt and Road initiative:

China's engagement in Africa, a focus of the Belt and Road Initiative (BRI), grew rapidly in the two decades before the COVID-19 pandemic. Chinese companies built ports, hydropower plants and railways across the continent, financed mainly through sovereign loans. Annual lending commitments peaked at $28.4 billion in 2016, according to the Global China Initiative at Boston University.
But many projects proved unprofitable. As some governments struggled to repay loans, China cut lending. COVID-19 then pushed it to turn inward, and Chinese construction projects in Africa fell.

The chart above indicates what's happened to the much-touted Belt and Road Initiative. Of course lending without conducting substantive due diligence to regimes with questionable governance records was not conducive to being paid back on time! Post-COVID and all these post-non-performing loans, the Chinese are back in Africa. However, the pretense of mutual benefit is largely gone, replaced by a massive focus on extracting more than Westerners can. Yes, it's neocolonialism at its crudest, but it is what it is:

Worse still, lots of Chinese goods are flooding these African countries at low prices, creating substantive trade deficits with China all over the continent. In trade terms, it's likely a case of "dumping":

With one of Africa's largest trade deficits to China, Kenya has been pushing to increase access to the world's second-largest consumer market, recently gaining it for avocados and seafood. But cumbersome health and hygiene regulations mean Chinese consumers remain out of reach for many producers...

But Chinese manufactured goods kept coming. That's not sustainable, said Francis Mangeni, an advisor at the Secretariat of the African Continental Free Trade Area. Unless African nations can add value to their exports through increased processing and manufacturing, he said, "we are just exporting raw minerals to fuel their economy."

The story never changes of foreigners exploiting natural resources and then profiting by selling higher value-added goods in these African nations, thereby stifling indigenous development that would occur by garnering capabilities to produce more sophisticated products. The Chinese can keep repeating holier-than-thou rhetoric about not being like those Western imperialists exploiting Africa with naked greed, but it's what they do and not what they say that ultimately counts.

Turkish Football Reflects National Malaise

♠ Posted by Emmanuel in at 5/24/2024 02:23:00 PM

I haven't had a sports feature in ages, so here's one: The pitch invader--a fan who goes down to the football field--is a fixture of the sport the world over. However, did you wonder if such sporting hooliganism meant more than a lack of impulse control? Its repeated occurrence in Turkey, often accompanied by violence, has spurred a broader examination in the pages of the Financial Times. The overall thesis that sports reflect wider culture is not quite unique. If you consider football as an institution of significance along with, say, government, you may see things in a difference light:

Mistrust among fans over institutions that are supposed to safeguard fairness in Turkish football — including referees, the country’s football federation and club leaders — lies at the heart of the crisis in Turkish football, according to industry insiders and analysts. 

“​​Each week there’s a massive discussion about referee calls,” said Özgehan Şenyuva, a professor at Ankara’s Middle East Technical University who has studied Turkish fandom. “There’s always this search for something deeper, some kind of a conspiracy,” he added. 

Further links may be drawn to the conspiracy-minded populism of longtime Turkish President Tayyip Erdogan, who sees shadowy forces out to undermine his leadership in all things--including football, apparently:

The suspicion that shadowy forces are at play in deciding matches reflected Turks’ dwindling faith in politics and society more broadly, according to Şenyuva. It comes amid rising concerns over the rule of law, judicial independence and a crackdown on civic society as President Recep Tayyip Erdoğan begins his third decade in power.

Koç’s predecessor at Fenerbahçe, Aziz Yıldırım, was in 2012 found guilty of match rigging and sentenced to six years in jail. Yıldırım was later acquitted, with the government alleging that a group, which it says was behind the 2016 coup attempt against Erdoğan, had initiated a wide-range conspiracy to discredit dozens of leading figures in Turkish football.

As with many things in decline, it is reflected in the finances. In inflation-riddled Turkey, it's obvious:

Turkey’s leading clubs posted a pre-tax loss of €310mn in the 2022-2023 season, according to Uefa, which oversees European football. Collectively Turkish teams recorded €1bn in gross bank debt, with 18 clubs in a negative equity position.

Erdoganism's distrust in officialdom and financial distress stretch far and wide in Turkey.

Making US Permian Basin Part of OPEC (Really)

♠ Posted by Emmanuel in , at 5/05/2024 04:56:00 PM

In a matter of days, ExxonMobil will complete its $60 billion acquisition of Pioneer Natural Resources, which is one of the concerns that have made drilling for shale in the Permian basin a highly lucrative endeavor for American energy. However, before you conclude that it's a tribute to American ingenuity, there's a twist here that may surprise you involving a host of foreign actors.

Pioneer's founder Scott Sheffield is being named by the US Federal Trade Commission in attempting to coordinate--that is, collude--with OPEC+ on the pricing of energy products. Aside from the company he wishes to keep being rather dodgy sorts including Russia's Putin, there are free market principles being violated here that are more pertinents to the FTC's mission. So, the FTC is advising ExxonMobil that its purchase of Pioneer will only push through if the combined entity does not have Sheffield as a board member or an adviser:

Scott Sheffield, founder and longtime CEO of a leading American oil producer, attempted to collude with OPEC and its allies to inflate prices, federal regulators alleged on Thursday. The Federal Trade Commission said Sheffield, then CEO of Pioneer Natural Resources, exchanged hundreds of text messages discussing pricing, production and oil market dynamics with officials at the Organization of the Petroleum Exporting Countries, or OPEC, the oil cartel led by Saudi Arabia.

Regulators say Sheffield used WhatsApp conversations, in-person meetings and public statements to try to “align oil production” in the Permian Basin in Texas with that of OPEC and OPEC+, the wider group that includes Russia. “Mr. Sheffield’s communications were designed to pad Pioneer’s bottom line — as well as those of oil companies in OPEC and OPEC+ member states — at the expense of US households and businesses,” the FTC complaint said.  

With no charges being made, Sheffield and the firms involves have decided not to contest the FTC's prohibition of his involvement. From a political angle, prosecuting a pillar of the US energy at a time of historically elevated oil prices doesn't seem to me like a winning election strategy. So, the FTC is just making a slap on the wrist for what would otherwise be a massive case of collusion. Also remember that the US is friendly with several unsavory regimes within OPEC.

Still, it would've been interesting if it'd have gone to trial to learn how this guy worked with the likes of Venezuela's Maduro and other characters to screw US consumers in the interests of greater (unwarranted) profits. 

Me? I try to use the least of the dastardly substance as possible to avoid enriching these kinds of folks.

Should Frozen Russian Assets Fund Ukraine?

♠ Posted by Emmanuel in ,, at 4/20/2024 09:23:00 PM

The adversaries during more cordial times.

Unbeknownst to many, one of the linchpins of the post-WWII global infrastructure is coming under sustained attack... from its main beneficiary. The United States has been extraordinarily fortunate that its national debt is regarded as being among--if not the--safest investment around. IOUs in the form of US Treasuries are a standard dollar holding across the world, and this demand allows the US to run an unimaginable debt of $34.58 trillion at the time of writing.

Would it be strange if the US were to put its debt's status as a safe asset in jeopardy? Well, that's precisely what's going on with the House of Representatives advancing legislation--the REPO Act--meant to use Russia's Treasury holdings and suchlike for funding Ukraine's defense from Russian invasion.

The REPO Act, which would authorize Biden to confiscate the frozen Russian assets in U.S. banks and transfer them to a special fund for Ukraine, is part of the foreign aid package that was stalled for months in the House. More than $6 billion of the $300 billion in frozen Russian assets are sitting in U.S. banks. Most of the $300 billion are in Germany, France and Belgium.

To be sure, Vladimir Putin hedged his bets by keeping much more euros than dollars in his reserve holdings:

[F]ollowing Putin’s invasion of Ukraine, all of the Group of Seven (G7) countries including the U.S., U.K., Canada, France, Germany, Italy and Japan banded together and froze all of the $300 billion dollars of Russian foreign currency reserves held in banks in those countries, most of the money in Europe.

“The Russians were surprised when, right after the war started, the Europeans took the exact same measures as the United States, freezing all of the reserves that were there and the Japanese did the same, which is why most of Russia’s reserves today are frozen in western banks,” said Chris Miller a professor at the Fletcher School at Tufts University.

Now, there are two main takes on the implications of giving Ukraine the confiscated reserves of Russia. Critics say that other countries will lose faith in investing in American sovereign debt since the US does not have apparent qualms about taking away other countries' investments. For instance, here is Christopher Caldwell:

If Russia, China and other diplomatic rivals were to decide that their dollar assets were vulnerable and that they could no longer trust the dollar as a means of exchange, we would feel the pain of that $34 trillion in debt in a way that we don’t now. Retaining the advantages of a reserve currency depends on our behaving as a trustworthy and neutral custodian of others’ assets. If we start stealing people’s money, that could change...

For decades now, the United States has been deferring hard decisions at home and abroad and papering over partisan divisions with the tens of trillions of dollars that our advantageous international position has allowed us to borrow. Our options, though, are narrowing. If [Speaker Mike] Johnson thinks the United States is “projecting weakness” now, wait till he sees it without its reserve currency.

Meanwhile, the REPO Act's champions high-mindedly echo Michael McFaul. In the NBC News article in the initial link:

McFaul, whose been lobbying for the REPO Act for months, clapped back at Caldwell’s assertion and said the use of Russian assets for Ukraine would send an important message to autocratic nations around the world. “There are those that say, 'Well, this will hurt the dollar. It’s bad for our reputation.' I have a pushback to that. I don’t want criminals investing in American Treasury bonds,” McFaul said.

Actually, I side more with the REPO Act skeptics in the sense that "beggars can't be choosers": The US is able to fund its chronically huge budget deficits by not being too picky about its creditors. There are any number of regimes with questionable good governance records--you can easily identify them yourselves from a list--that lend tens of billions of dollars to the United States. Will they take fright if the US proceeds with legislation meant to strip Russia of billions? 

You know, we may find out real soon... and the consequences of an answer in the affirmative could literally reshape the postwar global infrastructure.

AN ASIDE regarding the EU: With the bulk of Russian foreign exchange reserves in the EU, the latter are understandably resistant to US President Joe Biden's pleas to also donate frozen Russian assets to Ukraine. With the relatively new euro single currency in a precarious state ever since global financial crisis, its users are not exactly excited about the Yanks pressuring them to also use seized Russian monies to fund Ukraine. Having the bulk of the frozen Russian reserves and being right next door, the EU is collectively nowhere near as gung-ho about the matter. At most, EU suggestions are half-hearted like just using interest on frozen Russian reserves to fund Ukraine. People act in their interests, and the Europeans are understandably reticent despite (or because of) their enormous distrust of Russia.

Young Worker Exodus from Low Pay Japan

♠ Posted by Emmanuel in , at 4/13/2024 04:33:00 PM

Outbound 'r' Us.

China is famously in dire economic straits, but how's Japan really doing to solve its longstanding problems like a dearth of working-age citizens? Here's a wrinkle in what is effectively Japan's attempt to devalue its way to prosperity: Just as the yen has fallen to a 34-year low of 153-something to the dollar, the resulting peanuts wages in Japan vis-a-vis those in other developed countries are making younger folks depart in search of higher pay.

With similar visa programs [to Australia's] in the U.K., Canada and New Zealand recovering post pandemic, the outflow of talent risks exacerbating Japan’s acute labor shortage. It’s also a sign that many younger Japanese aren’t buying into the nation’s economic optimism as it exits from decades of deflation. "Youth are questioning Japan’s economic outlook,” said Yuya Kikkawa, an economist at Meiji Yasuda Research Institute. "Living conditions are far tougher than the headline inflation figure suggests.”

The Bank of Japan finally scrapped the world’s last negative interest rate last month amid signs a virtuous cycle of wage gains is feeding demand-led inflation. But even after Japanese labor unions won their biggest wage hike in more than 30 years last month, there remains a notable gap in real wages with other advanced economies. In 2022, average annual wages in Japan were $41,509, compared with Australia’s $59,408 and $77,463 in the U.S., according to the latest data from the Organisation for Economic Cooperation and Development.

You see, the old (pre-inflation) deal was for Japanese workers to accept lower wages in exchange for job security during uncertain economic times. However, that deal no longer works as the cost of living has risen:

A long-running trade off that put job security ahead of higher pay made more sense when prices were barely moving. Now with inflation at its strongest in decades, Japanese are starting to realize that years of static wages leave many of them budgeting each month before their next pay check.

"Japan’s wages hadn’t risen at all for 20 years while other countries were increasing theirs,” said Atsushi Takeda, chief economist at Itochu Research Institute. "With the yen getting weaker, the gap has become even bigger.”

Some 14,398 Japanese were granted working holiday visas in Australia in fiscal 2022-23, the highest number in Australian government data going back to 2001. It allows 18- to 30-year-olds (or 35 for some countries) to have a 12-month holiday and work in roles ranging from farming to hospitality, nursing, construction or office work to fund their trip. There’s also an option to extend as long as three years.

So, not only is Japan lacking working-age people to take up the nation's workload, but they are also leaving in ever-larger numbers since the pay at home is comparatively low by OECD standards. Even in Japan as its stock market hits record highs, the "main street" reality is rather grimmer.

“Adios to the Chinese Dream” (Xi’s Theme Song)

♠ Posted by Emmanuel in at 4/07/2024 03:17:00 PM

With apologies to Rodney Crowell... Excuse me mister but what did you say? / My hard-earned money’s all gone away / Xi ain’t into capitalism you see / The stock market is just no place to be. Voila, An American Dream is a catchy ditty that I've turned into a lament for the loss of the so-called "Pacific Century" that academics so love[d] to talk about. Supposedly, China's economic ascent would power the entire Asia-Pacific into a period of global dominance. 

Let's just say that hasn't been how things have turned out. In the interests of "national security," the "national interest," or whatever the Communist Party claims is best in a patriarchal sense, it's gone after industry after industry--digital payments, after-school tutoring, residential real estate... the list goes on and on. Given the level of state intervention in economic matters, it's ironic that the PRC keeps wanting to shed its designation as a "non-market economy" by the United States and others. It's derogatory--Vietnam wants to shed the label ASAP--but accurate so far the PRC goes insofar as winners and losers are not determined by the market but rather by government fiat.

Given limited space to air discontent over state policies, disgruntled Chinese investors have taken to using the US embassy social media account to bash the Communist Party, of all channels. Presumably, the Yanks are less likely to censor criticism of the authoritarians:

Many Chinese are venting their frustration at the slowing economy and the weak stock market in an unconventional place: the social media account of the U.S. Embassy in Beijing. A post on Friday on protecting wild giraffes by the U.S. embassy on Weibo, a Chinese platform similar to X, has attracted 130,000 comments and 15,000 reposts as of Sunday, many of them unrelated to wildlife conservation. "Could you spare us some missiles to bomb away the Shanghai Stock Exchange?" one user wrote in an repost of the article...

The Weibo account of the U.S. embassy in China "has become the Wailing Wall of Chinese retail equity investors", another user wrote.The U.S. embassy did not immediately respond to a Reuters request for comment.

The Pacific Century has been crushed underfoot by Chinese authorities who are obviously more interested in maintaining their grip on power than the (financial) well-being of their citizens. I've even penned a song about it. Sort of.

Fleeing China II: Foreign Divestment Edition

♠ Posted by Emmanuel in , at 11/06/2023 02:04:00 PM

Bing prompt: "Draw a businessman leaving China".

Hot on the heels of the previous post about how Chinese are showing at the United States' southern border seeking asylum from increasingly dire economic conditions in the PRC, we get more news of this sort. Just as people are leaving China, so is capital: For the first time its records, the PRC has seen a net outflow of Foreign Direct Investment (FDI). On balance, more FDI is leaving than entering China, once the world's most notable destination for investment. From the Nikkei Asia Review

Outflows of foreign direct investment in China have exceeded inflows for the first time as tensions with the U.S. over semiconductor technology and concerns about increased anti-spying activity heighten risks. The shift was reflected in balance-of-payments data for the July-September quarter released Friday by the State Administration of Foreign Exchange.

FDI came to minus $11.8 billion, with more withdrawals and downsizing than new investments for factory construction and other purposes. This marked the first negative figure in data going back to 1998.

To be sure, there are overseas precursors for this shift. The US is keen on banning cutting-edge knowledge on semiconductors and artificial intelligence from leaking to China:

Escalating tensions with the U.S. are one reason for the decline in foreign investment. In a survey taken last fall by the American Chamber of Commerce in the People's Republic of China, 66% of member respondents cited rising bilateral tensions as a business challenge in China.

In August, the U.S. announced tighter restrictions on chip and artificial intelligence investment in China. Washington is coordinating with Beijing ahead of a summit meeting between Presidents Joe Biden and Xi Jinping in November, but the U.S. remains committed to technology restrictions in the name of economic security.

Looking at foreign investment in the semiconductor field by destination, China's share has already shrunk from 48% in 2018 to 1% in 2022, according to U.S. research firm Rhodium Group. In contrast, the U.S. share rose from zero to 37%. The combined share of India, Singapore and Malaysia grew from 10% to 38%.

However, American chip and AI concerns obviously do not make up all potential sources of FDI to China. It is here where a decidedly unfriendly foreign investment policy climate factors in. You name it: from corporate espionage to various forms of harassment of overseas businesses under dubious pretenses... today's PRC leadership does not think much of how others perceive these actions meant to promote domestic industry at the expense of foreign concerns.

Europeans, for instance, cite only cosmetic efforts to improve prospects for FDI:

Beijing has been seeking to reverse capital outflows in the face of mounting economic challenges. But such efforts appear to have failed to assure investors. The China International Import Expo (CIIE), an annual event launched by President Xi Jinping in 2018 to portray China as an open market and improve its trade ties, kicked off on Sunday. But the European Union Chamber of Commerce in China criticized the event last week as a “showcase.”

“European businesses are becoming disillusioned as symbolic gestures take the place of tangible results needed to restore business confidence,” the chamber said in a Friday statement. “The CIIE was originally intended as a showcase of China’s opening up and reform agenda, but it has proven to be largely smoke and mirrors so far,” Carlo D’Andrea, vice president of the chamber, said in the statement.

Having done nearly everything possible to discourage FDI, is it any wonder it's leaving China?

Chinese Migrants at US Border: PRC's Dire Straits

♠ Posted by Emmanuel in , at 10/30/2023 02:00:00 PM
The blog's first AI image c/o Bing: "Draw a Chinese person walking through a Panamanian jungle."
A usually good indicator of an underwhelming economy is of a country's citizens departing it for greener pastures. The year is 2023, not 1882 when the US passed the Chinese Exclusion Act to stop a massive influx of Chinese immigrants. Moreover, isn't the 21st century supposed to have been the Asian Century according to some prognosticators? My belief is that policy missteps by Xi Jinping have greatly dented the forward momentum of China in recent decades, recently exacerbated by endless lockdowns during the COVID-19 pandemic. At any rate, you may be surprised that the PRC--not some Latin American country--now ranks fourth in sending folks across the Darién Gap linking South and Central America with hopes of entering the United States. From the Associated Press:

Chinese people were the fourth-highest nationality, after Venezuelans, Ecuadorians, and Haitians, crossing the Darién Gap during the first nine months of this year, according to Panamanian immigration authorities. Chinese asylum-seekers who spoke to The Associated Press, as well as observers, say they are seeking to escape an increasingly repressive political climate and bleak economic prospects.

They also reflect a broader presence of migrants at the U.S.-Mexico border — Asians, South Americans, and Africans — who made September the second-highest month of illegal crossings and the U.S. government’s 2023 budget year the second-highest on record.

As bad as things may be Stateside, let's say they are decidedly worse in China (where you certainly aren't free in a conventional sense). 

The pandemic and China’s COVID-19 policies, which included tight border controls, temporarily stemmed the exodus that rose dramatically in 2018 when President Xi Jinping amended the constitution to scrap the presidential term limit. Now emigration has resumed, with China’s economy struggling to rebound and youth unemployment high. The United Nations has projected China will lose 310,000 people through emigration this year, compared with 120,000 in 2012...

“This wave of emigration reflects despair toward China,” Cai Xia, editor-in-chief of the online commentary site of Yibao and a former professor at the Central Party School of the Chinese Communist Party in Beijing.

“They’ve lost hope for the future of the country,” said Cai, who now lives in the U.S. “You see among them the educated and the uneducated, white-collar workers, as well as small business owners, and those from well-off families.”

Those who can’t get a visa are finding other ways to flee the world’s most populous nation. Many are showing up at the U.S.-Mexico border to seek asylum. The Border Patrol made 22,187 arrests of Chinese for crossing the border illegally from Mexico from January through September, nearly 13 times the same period in 2022. Arrests peaked at 4,010 in September, up 70% from August. The vast majority were single adults.

A common route involves landing in Ecuador and then continuing northward to reach the border:

The popular route to the U.S. is through Ecuador, which has no visa requirements for Chinese nationals. Migrants from China join Latin Americans there to trek north through the once-impenetrable Darién and across several Central American countries before reaching the U.S. border. The journey is well-known enough it has its own name in Chinese: walk the line, or “zouxian.”

 The monthly number of Chinese migrants crossing the Darién has been rising gradually, from 913 in January to 2,588 in September. For the first nine months of this year, Panamanian immigration authorities registered 15,567 Chinese citizens crossing the Darién. By comparison, 2,005 Chinese people trekked through the rainforest in 2022, and just 376 in total from 2010 to 2021.

If there is something that will shame the PRC into adopting sensible economic policies that benefit its general population, then its citizens fleeing China for distant America en masse during its supposed renaissance should be it. In the final analysis, the folks who've made China uninvestable are the PRC's leaders and not some malign foreign influence these leaders like to blame. 

The fruits of Xi Jinpingism are plain to see at the US-Mexico border.

Germans Brand Thee, USA, an ESG Disaster

♠ Posted by Emmanuel in at 6/06/2023 11:43:00 AM
Just one flagrant American ESG violation among countless others.

This news story from Bloomberg had me laffing so hard it hurt: Despite the action being rather novel--banning investment in US Treasuries over environmental, social and governance [ESG] grounds--it is undoubtedly true that America is an ESG disaster. Offhand, we can cite endless ESG offenses that the US has perpetuated on its citizens and the rest of the world. Among others:

  • Environmental: Being the world's second-largest carbon emitter and, historically speaking, by far the world's largest;
  • Social: Maintaining a persistent racial underclass of nearly half of blacks who have experienced inter-generational poverty despite accounting for less than 15% of the overall population;
  • Governance: Inflicting far more gun deaths annually than any other country by allowing largely unfettered sale and ownership of military-style weapons.

Now, it is not news to anyone that the US is a super-polluting, racialized and hyper-violent nation. However, it is news when others like the German state of Baden-Württemberg start calling a spade a spade... and put their money where their mouth is at:

That’s because the new environmental, social and good governance filters have resulted in US Treasuries ending up on an investing blacklist, due to America’s failure to ratify a number of treaties in areas including women’s rights and controversial weapons...

The bulk of Baden-Württemberg’s exclusions impact its equity and corporate bond portfolios. The law establishes the United Nations Sustainable Development Goals, the European Union’s Taxonomy Regulation and the Paris Agreement on climate change as the basis for future investment decisions.

Lest you think it's just one German state objecting to America, Inc., there are others:

Back in Germany, meanwhile, other states have taken similar steps. Baden-Württemberg, the only one of Germany’s 16 states with a coalition government led by the Greens, was inspired by a similar law in the smaller state of Schleswig-Holstein, where bans apply to US Treasuries as well as to fossil-fuel companies. And the pension funds of Brandenburg, Hesse and Germany’s richest state North Rhine-Westphalia are this year allocating as much as €11 billion to Paris-aligned stock indexes that exclude ESG laggards alongside Baden-Württemberg.

While I do not doubt the sincerity of these actions, I am not convinced that what international ESG-related treaties a country has ratified should constitute the basis for assigning ESG ratings to sovereign debt. Solability, for instance, has a "Global Sustainable Competitiveness Index" (GSCI) that takes into account a number of indicators similar to conventional bond credit ratings.

Ah well, I guess it's the thought that counts for these Germans.  

A Problem of Unstressful US Bank Stress Tests

♠ Posted by Emmanuel in , at 5/04/2023 04:35:00 PM

 Each day brings news of a distressed US bank about to take leave for the Great Central Bank In the Sky. Aren't US banks supposed to be safer now with the advent of greater macroprudential regulation? A common way to gauge the soundness of banks is through the use of stress tests that simulate how these financial institutions would fare in the wake of financial, well, stress. While Americans bicker about whether the 2019 loophole exempting midsize banks holding between $100 to $250 billion in assets from stress testing led to their currently precarious situation, even that may not have saved them.

Comparatively speaking, stress tests conducted Stateside may not be sufficiently rigorous in simulating scenarios that are detrimental to financial sustainability. It is fairly obvious that the higher rates we have these days are causing mismatches between what banks earn and what they must pay out. Oddly, however, recent US stress tests have not involved rising but rather falling interest rates. See the illustration above and commentary from the Peterson Institute:

But it’s not only for 2023 that this feature appears. Indeed, every severely adverse scenario used by the Fed since 2015 has the 3-month Treasury bill rate ending up at 0.1 percent. Many historic episodes of severe economic downturn have indeed been accompanied by low interest rates, as the Fed used its policy tools to support aggregate demand. But it is a bit strange that not since 2015 has a stress test involved rising interest rates.

One of the advantages of stress testing the banks every year is that their robustness to a variety of contrasting stresses can be assessed. Just repeating a broadly similar scenario year after year misses the opportunity to provide supervisors with potentially important information on vulnerabilities. It can also result in policymakers assuming that the banks are robust to more types of shock than is really the case.

Yet pointlessly repeating a broadly similar scenario each year is exactly what the Fed has been doing, as we can show here.

Have other regulatory authorities been administering stress tests as lax and unrealistic as American ones? Thankfully for the rest of the world, the answer is no. The European Central Bank--and remember that Switzerland is not an ECB member for those thinking of a certain defunct bank--has done its homework by simulating interest rate rises just as we are experiencing now:

Overall, our [ECB]  analysis shows that the euro area banking sector would remain broadly resilient to a variety of interest rate shocks. That would hold also under a baseline scenario of an economic slowdown in 2023 with the risk of a shallow recession, such as the scenario included in the December 2022 Eurosystem staff macroeconomic projections. Profitability would increase overall, driven by [higher] net interest income. However, provisions would also increase, reflecting potential difficulties for borrowers. Results for the overall impact on solvency remain on average fairly muted with great heterogeneity across banks, within and across different business models

The same hold true for Australian banks. Down under, their stress tests have likewise gamed out the implications of higher interest rates:

Higher inflation and higher interest rates could lead to larger credit losses despite continued, albeit slower, economic growth. The stress testing model can provide insights into the magnitude of potential credit losses and how important they could be for the capital positions of large and mid-sized banks. The model applies two principal stresses to examine the resilience of the banking system to higher inflation and interest rates:

  1. Higher inflation and higher interest rates on mortgages squeeze households’ real incomes, making it more difficult to service debt, which could lead to more defaults and larger credit losses for banks. Similarly, higher input costs and higher interest rates passed onto business loans can make it more difficult for businesses to service their debts, potentially leading to higher default rates (see ‘Chapter 2: Household and Business Finances in Australia’).
  2. Higher interest rates typically reduce the prices of housing and commercial property that are held as collateral by banks against their loans, which increases LGDs as well as PDs on loans.  

Having conducted these sorts of tests well before 2023, Australian banks look to be on firming footing.

While we hope that contagion does not spread to the Eurozone and the land down under, it certainly bears questioning why US stress tests did not involve scenarios involving deteriorating financial conditions due to sustained central bank rate rises in the face of persistently elevated inflation. While the subject matter can come across as esoteric, such things do impact Joe Average since taxpayers will ultimately foot the bill for cleaning up the mess caused by unstressful stress tests giving false comfort to financial authorities about the soundness of banks they regulate.  

UPDATE 1: Also see Krishna Guha's commentary in the FT. He warns that while the ECB did conduct asset side stress tests (e.g., holding low-yielding securities), it did not test how vulnerable Eurozone banks were to depositor flight like what has happened Stateside. That said, European depositors tend not to move their money around.

UPDATE 2: Former Federal Deposit Insurance Corporation chief Sheila Bair says the same thing about the latest batch of stress tests that banks passed: They did not model rising interest rates.