InvestMacro

By David McMillan, University of Stirling 

– In the weeks since the Brexit free-trade deal was announced on December 24, people in the UK have been coming to terms with the fact that “free” does not mean completely free. But while much of the focus has been on the Northern Irish border and the row over vaccines, the financial services sector, centred around the City of London, is also going through substantial upheaval.

The sector contributed £132 billion or 7% of the UK economy in 2019 and employs over 1 million people, half of them in banking. It came out of the talks with what is essentially a “no deal”, since services were not covered at all.

During the announcement, the UK prime minister, Boris Johnson, said that the deal “perhaps does not go as far as we would like” for financial services. This was primarily a reference to “equivalence”, which is the way that EU regulators grant market access to firms from a country outside the bloc, on the basis of deciding that the financial rules are similar to their own (and will remain so).

There was no such commitment to equivalence in the deal – only a memorandum of understanding that talks would stay open and there would be an agreement on financial services regulation by March 31 that would hopefully include equivalence. The City of London has been calling on Brussels to grant equivalence in these negotiations, but there is not much optimism that it will happen either in that timeframe or in any comprehensive way.

One major consequence is that UK financial institutions must trade euro-denominated shares and bonds from within the euro-bloc. Some temporary measures are in place to keep trades moving, such as the UK’s Financial Conduct Authority allowing UK companies to trade EU derivatives until June, but this business will also probably be lost after that.

One estimate from October 2020 suggested that even back then, £1.2 trillion in assets and 7,500 jobs had been moved in anticipation of what was to come. On the first day that trading shifted back to continental bourses on January 1, the volume amounted to nearly €6 billion (£5.3 billion).

There are still no signs of a mass exodus, however. For example, Deutsche Bank initially suggested that it may move up to 4,000 jobs to Frankfurt, but now that number looks more likely to be in the low hundreds. This could reflect a “wait-and-see” approach from financial institutions, or perhaps the benefits of being part of a cluster with a large support network of lawyers, accountants, risk specialists and so on, whose practices have evolved over decades to become world class.

Nonetheless, jobs relocated due to lack of equivalence are unlikely to come back if it is granted for particular market segments later, because routines and practices become settled. This could combine with the prospect of the “all-in-one-place” benefits of locating in London being diminished by the pandemic – if Zoom meetings are increasingly the norm, is being part of a cluster of connected businesses in one area still as important?

Professional strengths

But it’s not all bad news. One major City segment unaffected by Brexit is currency trading. While shares and bonds usually trade in the market where they are issued, currency trading takes place globally – mostly involving US dollar pairs, followed by pairs involving the euro and yen.

The UK has 43% of the global forex market, and this has increased by six percentage points in three years. The next highest is the US, with 16.5% and declining, while the Asian centres of Japan, Hong Kong and Singapore have predominantly been static.

In forex, London has several important advantages. The location and timezone are a midpoint between the US and Asia. It has scale in having such a significant number of international banks in one city, plus the network of supporting services. By comparison, EU expertise is scattered among centres such as Amsterdam, Frankfurt and Dublin. London also has the infrastructure required for state-of-the-art high-frequency trading, not least the transatlantic cabling landing stations and data centres.

So London will probably continue to dominate this market, and is well placed to benefit from a likely rise in the trade in emerging markets currencies. Their total trade now exceeds the yen, with the Chinese remnimbi the largest. Outside Hong Kong, more remnimbi are traded in London than anywhere else – more than £300 billion worth in 2019. London has also seen an increase in the issuance of remnimbi-denominated bonds issued outside of China (known as “dim sum bonds”).

In important areas like these, London will be competing much more with Asia than with Europe. London is also likely to continue to be a world leader in providing a place where disputes can be resolved and best practices can be monitored and maintained.

The right approach to the future

The pre-eminence in finance that London enjoys because of its cluster of specialists points to a vital issue as the UK emerges from Brexit: the key to the future is to maintain and enhance standards and regulatory oversight so that major firms continue to have confidence in London as a place to do business, resolve disputes and so on. Get this right and they will continue to invest.

No longer having to coordinate and agree with 27 EU countries should enable the UK to be more nimble in this regard, which could be a big advantage in attempting to corner emerging areas such as green investment and fintech. This could include developing and regulating new financial products that allow investors to positively engage with climate-change finance and cryptocurrencies. This would be a more beneficial approach to taking the financial sector forward than to focus on deregulation in a “big bang 2.0”.

The unavoidable reality is that financial services business and jobs will continue to be lost as a result of Brexit. But with a thoughtful, future-focused approach to managing the sector, there is also plenty of scope for it to rebound.

About the Author:

David McMillan, Professor in Finance, University of Stirling

This article is republished from The Conversation under a Creative Commons license. Read the original article.

By Dan Steinbock

– After four years of US-Sino tensions, the Biden administration could speed up US recovery, while restoring bilateral trust with China. That would foster global economic prospects. The reverse would undermine those prospects.

In the United States, the third wave of the COVID-19 peaked with 250,000 confirmed cases daily after the holiday period. Following the catastrophic mishandling of the pandemic by the Trump administration, total cases are approaching 27 million and the 440,000 deaths exceed US military fatalities in World War II.

After effective containment, confirmed cases in China remain below 90,000. With the Spring Festival holidays just days away, recent resurgences have renewed concerns about outbreaks and people have been urged to avoid travels during holidays. Despite some unease, public-health authorities believe a major outbreak is unlikely.

The key question is will China’s recovery prevail amid the dire global landscape and will US recovery begin later in the year. Due to the great size of the two economies, the former is vital to many emerging and developing countries, while the latter is critical to major advanced economies.

Both require restoring US-Sino trust after years of devastation.

US: growth in return for debt  

In the past year, US economy suffered a -3.5% contraction, despite ultra-low interest rates, low inflation, weak dollar and huge fiscal injections.

The CARES Act has kept economy humming between the lockdowns. However, exports have contracted. Industrial production has begun to recover, but even more slowly than consumption. Last November, US trade deficit in goods jumped to record high. Better days won’t return before a critical mass of vaccinations, around the 3^rd quarter of the year.

Here’s the caveat: The consumption-led recovery is leveraged to the hilt, relying on costly stimuli and rapidly-rising debt. In the past four years, US national debt has soared to more than $28 trillion, which puts US federal debt-to-GDP ratio at 128%.

How will the Democrats cope with the debt burden?

Instead of focusing on the size of US debt, says Jason Furman, President Obama’s former lead economic adviser, “policymakers should assess fiscal capacity in terms of real interest payments, ensuring they remain comfortably below 2 percent of GDP.” That would ensure adequate fiscal support and needed public investments, while maintaining a sustainable public debt.

As a share of GDP, the cost of servicing US debt has fallen since 2000, even as federal debt has increased. Low interest rates make it easier to pay off debts. However, deficits will more than double from 2010-19 to 10.9% percent of GDP in 2041-50, according to the nonpartisan Congressional Budget Office. By 2050, debt as a percentage of GDP will amount close to 200% of the GDP, as net spending for interest as a share of GDP could quadruple over 2031-50.

That’s a ticking time bomb.

China: key indexes signal broad recovery  

In 2020, China’s real GDP growth of 2.3 percent exceeded expectations. It was the only major economy to avoid negative economic growth. The performance relied on fiscal and monetary support, but as recovery is accelerating, monetary easing no longer seems warranted.

Although consumption is still constrained, investment is likely to be buoyed by government-financed infrastructure projects and solid performance in the property market. In November, the indexes for manufacturing, service, trade and consumption were encouraging, while growth in the 4^th quarter of last year rose to 6.5 percent year-on-year as consumers returned to malls, restaurants and cinemas.

Thanks to across-the-board recovery, the yuan has surged in strength against the US dollar and other major currencies.

Despite US-Sino tensions, foreign companies continue to pour money into China, thanks to the new foreign investment law to further open up the economy. In real terms, inbound foreign direct investment hit a record high of $144 billion in 2020.

In November, China signed the Regional Comprehensive Economic Partnership (RCEP) agreement with the 10 ASEAN member states, plus Japan, South Korea, Australia and New Zealand. That will boost regional trade and boost recovery.

The impressive increase in China’s exports pushed the trade surplus to a record high in December, with soaring demand for medical equipment to fight the pandemic. Thanks to the effective containment of the epidemic in the 2^nd quarter 2020, Chinese factories could respond to the global demand for such products, while other countries struggled with quarantines and lockdowns.

Importantly, the integration of the Chinese financial market with the global financial markets has accelerated, thanks to China’s regulatory reforms have. Consequently, foreign ownership of onshore Chinese stocks and bonds is likely to increase in 2021.

From Cold War to partners and rivals

After decades of US-Sino progress, Trump let high-level dialogues crumble in economic, law enforcement, and cultural affairs as well as diplomatic and security relations. These multi-level dialogues should be restored to foster strategic trust that took four decades to build and four years to kill.

After the Phase-I deal, China was obliged to buy $200 billion in additional US imports over two years on top of pre-trade war purchase levels. That was impossible amid Trump protectionism and global pandemic. What is needed is a reset to re-build a new appropriate path of dialogue in bilateral trade and advanced technology.

Before the trade wars, US investment to China averaged $15 billion per year, whereas Chinese investment in the US soared to $45 billion. US investment to China has persisted and most US companies plan to stay there. Yet, Chinese investment in the US has been forced to plunge. It is time to restart bilateral investment talks to facilitate a new rapprochement.

Despite political differences, US-China military exchanges used to feature high-level visits, exchanges between defense officials, and functional interactions. As these engagements fell by two-thirds in the Trump era, bilateral tensions have surged in South and East China Sea and a major conflict may be just a matter of time. What’s needed is a restart in military dialogues, at all levels and in all arenas.

China fueling over a third of global growth prospects

This year China’s economic growth is expected to rise further to 7 to 8 percent, followed by stabilization to 5.5% in 2022. Rapid recovery has brought Chinese economy closer to the US economic output, which it could surpass by the late 2020s.

Assuming the Biden administration can avoid new economic and pandemic pitfalls, US growth could rise to 5.0 percent, followed by stabilization to 2.2 percent in 2022.

In both cases, positive spillover effects would support global economic recovery.

The question is whether the Biden administration will opt for a cooperative scenario, which would result in some tariffs, moderated protectionism and efforts to avoid redundant conflicts, which would facilitate US recovery and global economic prospects. A reverse scenario would push those very same prospects back to the edge of global depression.

In December, the Organization for Economic Co-operation and Development (OECD) forecast that global GDP will reach the pre-pandemic level by the end of 2021. In this view, China will account for over a third of world economic expansion.

That contribution is critical to global economy.

About the Author:

Dr. Dan Steinbock is an internationally recognized strategist of the multipolar world and the founder of Difference Group. He has served at the India, China and America Institute (USA), Shanghai Institutes for International Studies (China) and the EU Center (Singapore). For more, see https://www.differencegroup.net 

The commentary was released by China-US Focus on Feb. 8, 2021