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Italy’s current economic crisis

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The day of reckoning has now come for the Italian economic crisis, worsened by the Covid-19 pandemic and the related lockdown.

As the Italian Statistical Institute (ISTAT) showed, 34% of Italian production has been negatively affected. The activity and operations of 2.2 million companies, accounting for 49% of the total, have also been suspended, but 65% of the entire export business has been closed.

This means that Italy’s economic system is changing.

All this has stopped – hopefully temporarily – the work of 7.4 million employees (44.3% of the total number of private employees not directly working in offices) and, along with the fear of coronavirus, it has obviously had a snowball effect, which has soon greatly reduced the confidence rate of consumers and businesses.

Production has been stopped for 34.2% of companies and the same holds true for 27.1% of value added.

 Therefore, considering the general lockdown envisaged, the fall in jobs currently affects 385,000 workers, 46,000 of whom are irregular, to the tune of 9 billion euros of wages.

The most affected sectors have been catering and accommodation (-11.3%), logistics, transport and trade (-2.7%).

 With sectoral closures envisaged until June, the overall reduction in value added amounts to 4.5%.

 The employees affected by definitive closures will be 900,000 approximately, 103,000 of whom are irregular, for a total amount of 20.8 billion euros of lost wages.

That is where the complex and long-standing E.U. issue comes in.

If we consider all the possible and already proposed E.U. funds, we are talking about 100 billion euro of resources, while it is very likely that Italy may have a “firepower” to generate credits and funds up to 300 billion euros. It would need them all and probably they will not be enough.

We should also consider the future 172 billion euros from the Recovery Fund.

The Conte II government has so far mobilized – albeit with badly drafted, superficial and even naïve rules and regulations – about 75 billion euros of resources, all based on budget deficit.

The so-called Cura Italia decree of last March “mobilized” 25 billion euros and 55 billion euros were mobilized with the recovery Decree of last May.

Certainly not everyone has yet reached this money – sometimes not even many of them. The funding to companies -shambolic and all foolishly used through the banking system, which is structurally inefficient – reminds us of what a great Lombard entrepreneur used to say years ago: “What do we industrialists ask of the State? That it gets out of the way”.

 The European Funds from SURE, the European Investment Bank and the European Stability Mechanism will mobilize about 270 billion euros throughout the European Union, with a share for Italy equal to 96 billion euros.

They are certainly not enough to rebuild the production system and compensate for damage.

 SURE is currently worth around 20 billion euros for Italy alone, but only to finance the Redundancy Fund, while 40 billion euros will be the Italian share of the 200 billion funds provided by the EIB only for SMEs.

 Therefore, Italy will go into debt – albeit on favourable terms -but not to get what it really needs.

 The rest will certainly have to be borrowed on the financial markets and with our own public debt securities which, however, at maturity will be secondary to the ESM or EIB loans.

Another key problem is that if and when – but it will happen anyway- the standard rules of the Stability Pact are back in place, we will be left with a very high debt, but still liable to all the reprimands of both the “markets” and the E.U. which, at that juncture, may also revise the terms and conditions of the loans already in place.

 For Italy, the Recovery Fund could make available the above stated 172 billion euros, of which 90 billion of loans and 81 billion of grants.

At the end of 2020, however, the Italian public debt will rise by as many as 15 points of GDP.

Why? Firstly, because the denominator will obviously be lower: the economic downturn resulting from the coronavirus crisis will be much wider than the one occurred in 2008, with a very severe 5.3% decrease compared to the GDP recorded in 2008.

Currently Confindustria, the General Confederation of Italian Industry, estimates a 6% drop in Gross Domestic Product, while Goldman Sachs estimates a 11.6% fall.

 Obviously there is also the inevitable increase in public spending, which is another public debt problem, hoping that speculation will stay calm – which is unlikely. There will also be a sharp drop in tax revenue.

 For example, it is estimated that 20% of the professionals registered with professionals Rolls and Associations risks being forced out of the market. It is no small matter. Other associations in the sector provide similar data.

Hence, if we assume a 6% GDP reduction, the debt-to-GDP ratio would rise from the 135% of late 2019 to at least over 153% at the end of 2020.

 With an11% GDP fall, the debt-to-GDP ratio in late 2020 would be equal to 163%.

Obviously, in such a context, even pending the suspension of the Stability Pact, Italy’s debt would be very hard to support.

Here the problem also lies in primary surplus. According to our data, even if we assume a limited 2.5% GDP rebound in 2021, with an unchanged cost of debt (2.6% in this case) there would be the absolute need for primary surpluses of at least 2.3% and 2.6%, respectively, in the case being studied of a 9% fall in GDP and also in case of an 11% collapse.

 In other words, the government should cut public spending always below 40 billion euros compared to taxation. This is impossible.

Therefore, we must necessarily monetise the extra-deficit with the ECB -monetise and not postpone payment until maturity – but for a very long period of time and for amounts that will probably be much higher than the current ones. It will also be necessary to issue common E.U. debt securities.

 Otherwise the markets, which have already laughed at a currency that has not even a common taxation and a single public budget rule, will pounce on the poor wretched Euro and destroy it.

 Then there is the ECB. On June 4, 2020 it announced the expansion of the Pandemic Emergency Purchase Program (PEPP) from 750 to 1,350 billion euros and also its extension until June 2021 and, in any case, until the end of the emergency situation.

However, there is additional data to analyse. Firstly, the current PEPP share mobilized for each E.U. Member State in the March-May 2020 quarter still corresponds, in essence, to the capital key.

The capital key is the mechanism whereby the ECB purchases sovereign debt in proportion to each country’s ECB share. The key is calculated according to the size of a Member State in relation to the European Union as a whole. The size is measured by population and gross domestic product in equal parts. In this way, each national Central Bank has a fair share in the ECB’s total capital.

 With two significant exceptions for the time being: France in a negative senseand Italy in a positive sense.

In other words, France is actually supporting Italy’s public debt. Obviously it cannot last long.

Even in the Italian debt case, however, the PEPP share does not seem to be as high as usually believed.

 The maximum absorption has long been recorded by the TLTRO purchase programme. Indeed, these are short-term operations and the markets know they will end soon.

What next? There is no alternative option.

Let us not even talk about the possibility that, based on the pressure from the so-called “thrifty countries”, well led by Germany, this mechanism may stop all of a sudden.

There is also another factor that should be better studied in Italy, namely the ruling of the German Constitutional Court based in Karlsruhe.

As made it very clear by the German Constitutional Court, it concerns the ECB programme known as Public Sector Purchase Programme (PSPP).

Created in 2015, it is still operational. It is not yet known for how much longer, to the delight of speculators.

On points of law, the German Constitutional Court challenged the 2018 judgment of the European Court of Justice, in which the Luxembourg judges considered the ECB’s intervention unlawful, but rather deemed that the E.U. Court should only confine itself to the actions and deeds manifestly exceeding the limits set by the Treaties and the ECB Statute.

 Therefore, the issue at stake in the current Karlsruhe ruling concerns the principle of proportionality (Article 5 TEU).

Based on the principle of proportionality, in fact, the E.U. can take action in “shared competence areas” (which are listed in Article 4 of the Treaty on the Functioning of the European Union) only if and insofar as the objectives of the proposed action cannot be sufficiently achieved by the Member States, but can rather be better achieved at E.U. level.

Certainly the monetary policy strictly falls within the E.U. and ECB competence, but the ECB’s action has inevitable repercussions on economic policy, which is in any case a shared competence area.

Hence, as the Karlsruhe judges maintain, the issue lies in defining whether the ECB enjoys independence even in relation to the treaties establishing it or whether the ECB itself should in any case follow the principles of the E.U. system to which it belongs.

 In essence, it is a matter of keeping fiscal and monetary policy still separate, and this is scientifically difficult. The dream of every badly aged and old-fashioned monetarist.

In essence, however, the Karlsruhe ruling tells us that the Euro area is sub-optimal(as we already knew, since Robert Mundell’s model certainly does not apply to the E.U. and the Euro) and is in any case not representative.

We have already known it, too, and indeed for a long time.

 The Euro is now a handicap for most E.U. Member States except Germany.

 The system of fixed rates with the European currency enables Germany to be increasingly competitive on the export side, in the absence of mechanisms to readjust foreign trade balances.

 Moreover, there is not even a real and homogeneous tax policy in the E.U.Member States, not to mention the ban on funding the Member States’ debt, which was established as far as the Maastricht Treaty.

With a view to avoiding this ECB funding mechanism, which may be rational but is illegal under the E.U. Treaties, Germany basically asks us to sell the public debt securities purchased by the ECB before their maturity.

That is fine, but it only means that a Member State’s debt can never be cancelled by purchasing the securities through its Central Bank.

Hence the securities continue to exist and be painstakingly renewed or possibly continue to re-enter the market.

Facts are facts, however, and without Mario Draghi’s quantitative easing (QE), France, for example, could certainly not have 32% of its public debt been bought back by the Eurosystem.

 When all E.U.Member States’ securities reach maturity, other ones are always purchased, so that the exposure remains around 33% and Germany is happy with this strict compliance with the law.

This 33% limit is self-imposed by the ECB so as to avoid one of the Karlsruhe conditions, i.e. the national voting thresholds, within the ECB, for rescheduling the debt of an individual State.

 It should be noted, however, that the ECB funds the absorption of E.U. countries’ public debt with the creation of money ex nihilo, like all Central Banks in the world. Nevertheless,this is still explicitly prohibited by the Treaties, but is barely justified, at legal level, with the aim of curbing inflation.

 An economic ideology which is now very old-style, but still very fashionable within the European Central Bank.

The various ECB sovereign debt purchase programmes are already worth over 1,000 billion euros, accounting for 8% of the entire Euro area.

However, with a view to really operating in this area, the ECB must also get rid of the German Constitutional Court’s first ruling of 2017, namely the 33% limit and hence the obligation to put the purchased securities back into circulation immediately after the end of the pandemic.

Reselling, on the secondary market, the securities still maturing would cancel all the monetisation benefits, but a new PEPP will be needed in the future, without quantitative limits and for a long period of time.

 And the ruling of the German Constitutional Court and Germany itself, with or without “Nordic” or “thrifty” watchdogs, will certainly get in the way. Hence for Italy (and France) there will not be much room for manoeuvre.

 The Fourth Reich is advancing not with the overheated “Tiger” tanks or with the Pervitinephedrine drugs, but with the monetary game on a non-rational currency.

Germany, however, said a very clear “no” to this process of debt repurchase and absorption, precisely with the Karlsruhe ruling of May 5.

The current PEPP is already outlawed under German law. We need to remember it or Germany will make us remember it.

 Italy, however, will not survive within the Euro area without QE, PEPP or any other trickery may be devised by the European Central Bank. The same holds true for France, although it still does not say so clearly.

 When, at the end of the three months allowed by the ruling of the German Constitutional Court, the Bundesbank withdraws from the purchase operations, it will obviously start again to put several thousand Bunds purchased with the ECB back on the market.

The sales of these securities will make rates rise in Germany, an increase that will be counteracted by the flight of Italian and French capital to buy German debt.

 At that juncture, Germany itself will autonomously carry out controls on capital, which is tantamount to paving the way for its exit from the Euro.

 What about the United States? At the end of 2019, before the lockdown, the share of speculative debt at high default risk amounted to 5,200 billion U.S. dollars.

Over the last two months of Covid-19 crisis, 1,600 companies a day have gone bankrupt in the United States, while consumer debt – a sort of crazy magic wand for American spending – has decreased by at least 2 billion U.S. dollars per month.

It is a severe drop for those who foolishly live on debt, not to mention that in late 2019 consumption was worth 75% of the U.S. GDP.

Therefore, considering the close correlation existing between consumer credit and consumption – and hence GDP – in the United States, there will almost certainly be a further crisis in companies’ solvency there.

 Since 2008 FED’s interventions have been worth 7,000 billion U.S. dollars, and the financial assets on the U.S. market are worth approximately 120 trillion dollars, i.e. 5.5 times the North American GDP.

Hence, not even the United States will give us a chance to find a way out or an exit strategy.

Advisory Board Co-chair Honoris Causa Professor Giancarlo Elia Valori is an eminent Italian economist and businessman. He holds prestigious academic distinctions and national orders. Mr. Valori has lectured on international affairs and economics at the world’s leading universities such as Peking University, the Hebrew University of Jerusalem and the Yeshiva University in New York. He currently chairs “International World Group”, he is also the honorary president of Huawei Italy, economic adviser to the Chinese giant HNA Group. In 1992 he was appointed Officier de la Légion d’Honneur de la République Francaise, with this motivation: “A man who can see across borders to understand the world” and in 2002 he received the title “Honorable” of the Académie des Sciences de l’Institut de France. “

Economy

Will the trade war between China and the United States come to end?

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USA China Trade War

Authors: Raihan Ronodipuro& Hafizha Dwi Ulfa*

The recent trade conflict between the United States and China has had a direct effect on some of the world’s economic players. These two countries are attacking each other with declarations and a trade war; the relationship between the two countries can be defined as a love-hate relationship because the two countries have a lot of mistrust for each other, but they still need each other.

The United States requires China as a global source of low-wage labor as well as a market for marketing American products, and China requires the United States as an investor in its companies as well as a market for marketing Chinese products known for their low-cost. What makes these two countries to be so cold to one another? To answer the question, let’s go back to when this trade war saga started.

Donald Trump is a successful businessman who owns enterprises and corporations all over the world. His candidacy for President of the United States in 2016 poses several concerns, including whether Trump is eligible to run for office. Trump replied by becoming the 45th President of the United States, succeeding Obama.

Trump adopted a protectionism agenda in order to shield the US economy from what he referred to as the “robber from China.” Trump has released a law stating that all steel and aluminum products entering the United States from Europe, China, Canada, and Mexico would be subject to 25% and 10% tariffs, respectively. Of course, China is outraged that the United States issued this order, as well as a related policy on all tribal products. Automobile components, as well as agriculture and fishery products, are manufactured in the United States.

In addition to the tariff battle, President Trump has expressly demanded that the TikTok and WeChat apps be prohibited from running in the United States. We know that these two technologies are very common in the larger population. Giant corporations, such as Huawei, have not survived Trump’s “rampage,” with the Chinese telecommunications giant accused of leaking US national security data to China through Huawei’s contract with US security authorities.

As a result, many US firms were forced to cancel contracts with Huawei or face sanctions. Google is one of the companies impacted by this contract termination, which means that all Huawei smartphone devices manufactured in 2019 and after will lack any of Google’s services such as the Google Play Store, Gmail, and YouTube.

Many of the world’s economic organizations predict a 0.7 percent drop in GDP in 2018 and a 2% growth in 2020. Coupled with the Coronavirus pandemic, the global economy has become increasingly stagnant, with global economic growth expected to be less than 0%.

Amid the tough trade negotiations between the United States and China, COVID-19 pandemic is also affecting their relationship. The United States domestic pressure to contain the pandemic, has led Trump to accuse China of being the virus spread source.  As a consequence, Trump put the US-China future relations at stake with his “China’s Virus” label. Besides, the United States absence from World Health Organization (WHO) during Trump administration along the pandemic, that become a new opportunity for China to expand its influence.  China uses the Covid-19 pandemic issue as an opportunity.

China’s successful in controlling the pandemic,  has also made China confident in facing the United States. Meanwhile, the United States is increasingly threatened by its position. Moreover, the United States dependence on overcoming Covid-19 which requires relations from many parties, including China, makes the United States’ position weak as a superpower.

This is what we hoped for when Biden took office. Many consider President Joe Biden to be willing to “soften” the United States’ stance on the trade war with China. After his inauguration on January 20, 2021, Biden has made many contacts with Beijing to address a variety of issues, one of which is the continuation of the trade war.

The United States and China agreed to meet in Anchorage, Alaska, on March 18-20, 2021, to discuss this issue. The meeting produced no bright spots in the escalation of the US-China trade war, but rather posed questions concerning the Middle East, Xinjiang, North Korea, and Taiwan.

The Biden administration stressed that it does not plan to abolish various regulations passed during the Trump administration’s term in the trade war with China, but it also does not intend to employ the same negotiation strategies as the Trump administration, which seemed to be very offensive. Besides, the Biden administration must be careful, If Biden prioritizes domestic challenges then China has room to push its agendas, including in the field of technology and territorial issues

Furthermore, the Biden administration’s policy has shifted from imposing tariffs on China to investing in industries that Biden believes are less competitive with China, such as nanotechnology and communication networks.

In conclusion, the trade war between the United States and China has ushered in a new age in the global economy, one in which China is going forward to replace the United States’ status as a world economic force, something that the United States fears.

The door to investment is being opened as broad as possible, the private sector is being encouraged to participate (under tight government oversight, of course), the cost of living is being raised, and the defense spending is being expanded. Today, we can see how the Chinese economy is advancing, becoming the world’s second largest economy after the United States, selling goods all over the world to challenge the United States’ status, and even having the world’s largest military after the United States.

The rise of China is what the US is scared of; after initially dismissing China’s problem as insignificant, the US under the Trump administration takes China and Xi Jinping’s problems seriously by starting a trade war that is still underway.

Will this trade war enter a new chapter in the Biden presidency, where the relationship with China will be more ‘calm’ and the trade war can be ended, or can it stalemate and maintain the stance as during the previous president’s presidency?

*Hafizha Dwi Ulfa is a Research Assistant of the International Relations Study Center with focus analysis in ASEAN, East Asia, and Indo-Pacific studies.

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The “Retail Investor Revolution” in the U.S.

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Authors: Chan Kung and He Jun

Recently, the battle between retail investors and institutional investors is taking place in the U.S. stock market, with some short-selling institutional investors being driven to the brink of bankruptcy. The rise of the retail investor, which has led to huge volatility in the U.S. stock market, is nothing short of a “retail investor revolution” in a market dominated by institutional investors.

GameStop (GME), the world’s largest video game and entertainment software specialty retailer with a chain of nearly 7,000 retail stores worldwide, has continued to underperform in recent years under the impact of online gaming, with its stock price dipping from USD 28 per share in 2016 to USD 2.57 per share in April 2020. Nevertheless, since January 11, 2021, retail investors have been bullish on GME that it has soared to as high as USD 483 per share, a “crazy” move that drove Melvin Capital, a hedge fund with a large short position in the company, to the brink of bankruptcy. So far this year, short-sellers had lost USD 19.75 billion on GME, according to fintech and analytics firm S3 Partners. S3 Partners estimates that short positions in GME lost more than USD 7.8 billion on January 29 alone. The “long-short” battle between retail investors and institutional investors ended with the retreat of institutional investors.

Other U.S. stocks that have recently been caught up in the “long-short” battle have also been volatile. On January 28, American Airlines plunged after opening nearly 31% higher, closing up 9.30%. Castor Marintime, a Cypriot dry bulk shipping company, also plunged after opening with a 67.62% jump, closing up 14.77%. AMC Theatres, a U.S. cinema chain on the verge of bankruptcy, closed down 56.63% on the same day after soaring more than sevenfold in two weeks. Canadian mobile phone company BlackBerry and the U.S. fashion clothing chain Express also fell about 42% and 51%, respectively.

The U.S. capital market has long been dominated by institutional investors, and in mid-2018, institutional investors held 93.2% of the market value of the stock market, while individual investors held less than 6% of the market value. In the U.S. capital market, where institutions are the absolute majority, the market system and regulatory rules are set in favor of institutional investors. Market participants, i.e., investors (institutional investors and retail investors), regulatory authorities, and financing entities (enterprises) have formed a set of “self-consistent” system. However, the “retail investor revolution” has disrupted the conventional ecology of the market, with some young retail investors from the WallStreetBets (WSB) group on the Reddit forum throwing institutions into disarray. This “long-short” battle has put retail investors, represented by the “WallStreetBets”, at center stage and secured support from the top elites, including Elon Musk. In the face of this sudden “retail investor revolution”, the reasons and possible effects are worth in-depth observation and thinking.

First, who opposes the “retail investor revolution”?

The answer is of course, Wall Street as represented by institutional investors, who are the “establishment” in the capital market and represent the mainstream and value perspectiveof the financial market. Goldman Sachs, a prominent investment bank, saying the butterfly effect of the GME short squeeze is leading to the worst short squeeze in the U.S. stock market since the financial crisis. Over the past 25 years, the U.S. stock market has seen a number of severe short squeezes, but none as extreme as has occurred recently. Goldman Sachs warned that if the short squeeze continued, the entire financial market would collapse. According to Goldman Sachs, unsustainable excess in one small part of the market has the potential to tip a row of dominoes and create broader turmoil. In recent years, the pattern of low volume and high concentration in U.S. stocks has increased the risk of funds unwinding their position across the market.

Market maker brokers and trading platforms have also imposed strict restrictions on retail trading. In the midst of a fierce battle between retail investors and short sellers in the U.S. stock market, for example, several brokerage houses, including Robinhood, a zero-commission online brokerage, and Interactive Brokers, one of the largest online brokerages in the U.S., abruptly shut down buying of WSB related stocks such as GME, AMC, and Nokia. Robinhood said the restrictions had to be put in place because of the pressure on data processing and margins brought by the volume of retail trading. But the move immediately drew accusations from the market that the decision was “market manipulation”.

Second, what gathers a group of scattered retail investors?

According to Chan Kung, founder of the ANBOUND, the answer lies in the internet. A group of young retail investors gather in a Reddit subsection called WallStreetBets (WSB), and rely on the convenience of the internet to mobilize and convene, forming a force that can influence institutions in specific areas (such as WSB concept stocks). As in recent years, public use of social networking platforms in the social and political spheres has shifted to the stock market investment sphere.

Chan also pointed out in that the role of the internet is not only in mobilizing and convening, but also in providing and sharing quality analysis. The dominance of institutions in the stock market is not only reflected in funds, but also in research capabilities. They rely on professional teams to collect information, conduct market research, and conduct modeling and analysis, forming a certain information monopoly and an overall investment advantage over retail investors. However, the development of the internet has broken up this information monopoly. Due to the convenience of information acquisition and sharing, some small institutions and professional investors also have a high analytical ability. Their participation and sharing make the Internet platform another kind of “large institutions”, which provide investment analysis and advice to retail investors in a distributed manner. The rapid information sharing and investment actions make the retail investor cluster a “disruptor” and “challenger” that cannot be underestimated in the capital market. Chan Kung also pointed out that among the retail investors, a group of people with strong information ability will further decide the market trend in the future, and the investment in the capital market will gradually become information-oriented, and the size of the funds will not be as important as in the past.

Third, how would the U.S. financial regulators handle the short squeeze and the stock market turmoil?

The U.S. Securities and Exchange Commission (SEC) said on January 29 that it is closely monitoring extreme price volatility and will review entities that “unduly inhibit” traders’ ability to trade certain stocks. The SEC also added that extreme stock price volatility has the potential to expose investors to rapid and severe losses and undermine market confidence, and that market participants should be careful to avoid “illegal” manipulative trading activity. The SEC is working with regulators to assess the current situation and review the activities of regulated entities, financial intermediaries, and other market participants. White House Press Secretary Jen Psaki said that Treasury Secretary Janet Yellen and the White House economic team are closely watching the stock market activity around GameStop and other heavily shorted companies. She called the trading in the video-game retailer “a good reminder, though, that the stock market isn’t the only measure of the health of our economy.” Fed Chairman Jerome Powell declined to weigh in on the activity around GameStop. “I don’t want to comment on a particular company or day’s market activity or things like that. It’s just not something really that I would typically comment on,” Powell said. This information suggests that the U.S. regulatory authorities are cautious in their stance on market volatility, but hope that the market will remain stable and compliant.

Fourth, what will happen to the market relationship between retail investors and institutions?

The “retail investor revolution” has exposed the contradiction between retail investors and institutions, and made the market relationship between retail investors and institutions the focus of the market. Retail investors are within their rights to take legal action against brokerage houses for restricting trading. In the market, it is not only the so-called “regulators” that can deliver justice. Chan Kung stressed that the real problem with institutional restrictions is that if Wall Street establishes a firewall for market trading and prohibits retail investors from uniting to make the market, then the market becomes an inter-agency market, and may even further evolve into a false trading market, shaking the foundation of the entire market system. Therefore, this unprecedented short squeeze triggered by retail investors has exposed a systemic defect in the U.S. capital market. To solve this problem, there is the need to continue observing and following up.

Remarkably, the same problem exists in China. People who speculate in Chinese stocks gather on WeChat and online forums to lead a large number of hot money to hit the market. Drawing on the example of the “retail investor revolution” in the U.S., the following questions are worth considering: Is such trading activity legal? If it is “illegal”, then what kind of market has the Chinese stock market become? If there are certain winners in the market, limits on how much the stock price can go up and how much they can go down, and, in short, all the criteria that are set internally, isn’t the market trading becoming akin to sham game? Such questions are also worth pondering in China’s retail investors-dominated stock market.

Final analysis conclusion

The historical experience shows that the enthusiasm of the market can never prevent the laws of the market from working, and that the rules formed on the basis of previous experiences and lessons are still the main keynote of the market. At the same time, one should also see that with the changes in the information world and the changes in the behavior of retail investors, retail investors are forming a force that can affect the market. Therefore, certain changes in the market system and regulatory approach as a result are likely to be a future trend.

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Economy

ESG as the New Loadstar for the Global Economy

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The ills of the world economy and the frequency of crises may in part emanate from a loss of the sense of direction. With economic policy rules increasingly undermined at the level of countries and international organizations, the resulting loss of an anchor resulted in a rising frequency of economic crisis episodes. Instead of the weakening norms and top-down conditionality of international organizations a new set of rules and standards is starting to propagate throughout the global economy from the micro-level of the corporate and financial world. This new moral code is epitomized in the ESG (environment, social, governance) framework, with the propagation of ESG principles taking place across all key segments of the global economy.

The buy-side is witnessing a growing volume of assets under management that is tracking ESG principles by 2020 the value of global assets employing environmental, social and governance data to deliver investment decisions has almost doubled over four years, and more than tripled over eight years, to $40.5 trillion. Sell-side research is actively advancing ESG products in the corporate research space as well as in evaluating the macroeconomic implications of the use of ESG standards. The largest corporates are starting to compete in the ESG space, with a rising importance attached to corporate ESG ratings. At the country level governments are actively elaborating the national ESG strategies and evaluating the risks and the opportunities harboured in the rising global presence of the ESG agenda.

For corporates the importance of complying with ESG principles is driven increasingly by the rising share of ESG-driven investments, most notably among the largest institutional investors. According to PwC, ESG funds are set to hold more assets under management than their non-ESG counterparts by 2025, with ESG funds’ market share projected to rise to 57% in 2025, compared with the current 15%. In effect, companies not complying with ESG norms deprive themselves of a rising share of the global investment pool, which may impart negative implications for the companies market capitalization.

There may be also notable implications for countries and companies in terms of borrowing costs depending on the resilience and susceptibility to environmental factors as climate change. According to the estimates of the IMF, an increase of 10 percentage points in climate change vulnerability is associated with an increase of over 150 basis points in long-term government bond spreads of emerging markets and developing economies, while an improvement of 10 percentage points in climate change resilience is associated with a decrease of 37.5 basis points in bond spreads.

Importantly, there are notable regional variations in perceptions and regulatory regimes governing ESG factors as revealed by a Blackrock survey of 425 investors in 27 countries with nearly $25trn in assets under management. For more than half of the respondents in EMEA (51%), the top reason for adopting sustainable strategies was because it is the right thing to do, while just 37 per cent of respondents in the region said mitigating investment risk was a key consideration. At the same time in the Americas, mitigating risk is the second highest driver of adoption (49 per cent), followed by better risk-adjusted performance (45%) and mandate from board or management (45%).

The positive aspect of the ESG agenda is that it broadens the time-horizons of the world economy, including its financial and the real sectors, and allows for longer term risks and vulnerabilities to be incorporated into the current decision-making.

The Covid crisis was the bell toll that greatly underscored the importance of such a re-calibration of the time-horizons in economic strategies away from the excessive short-termism of the pre-Covid era. There is also the greater emphasis on sustainability as the core principle that aligns the operation of the corporate and financial markets with the broader global agenda as reflected in the UN development goals.

On the other hand, the transition towards the ESG principles also involves risks that have to do with the significant differentiation across countries in terms of values and preparedness to incorporate ESG standards. Developing economies, most notably those with a sizeable share of the mineral resource sectors in their economies, will likely find it more challenging to compete with advanced economies in the speed of ESG transformation indeed with respect to environmental standards there is the risk of green protectionism being employed against developing countries. Another risk may be the use of ESG norms as the new universal rules-based framework that separates rather than unites the global community.

In the end, just as the apocalyptic predictions regarding the coming of the WTO membership for Russia have proven to be unfounded so the ESG challenge may well turn out to be a factor of creative change rather than destruction. In many respects the ESG value code aligns well with the crucial exigencies facing Russia’s economy the need for longer time horizons in economic policy-making and investing as well as greater emphasis on environmental standards and social issues. For Russia’s financial realm this is an important element related to the development of deeper and less speculative markets, more emphasis being placed on education and support for the fledgling class of retail investors, and greater transparency and higher governance standards in the corporate world.

From our partner RIAC

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