As we have written on previous occasions, we believe the “Era of Transformation” which gives this newsletter its name is a multifaceted shift away from old dynamics to a new equilibrium (the “Day After”). Two key elements driving this shift are the energy transition (from conventional to renewable power) and the money transition (from traditional to digital currency). In our summaries this week, we bookend discussions of each of these transitions with an analysis of two economies showing the signs of transformation, China and Germany.

Chinese Economy Sees Near- and Long-Term Threats

Beyond Evergrande, China’s Property Market Faces a $5 Trillion Reckoning

– Quentin Webb and Stella Yifan Xie, Wall Street Journal

Xi Is Running Out of Time

– Daniel H Rosen, Foreign Affairs

Evergrande made headlines in late September when it announced it would be unable to meet its debt obligations, but the embattled Chinese property developer may only be the tip of a looming debt iceberg. Economists estimate that China’s property sector has over $5 trillion in debt; many of those obligations are beginning to look distressed as global confidence in China’s creditworthiness is shaken, with yields rising above 20% on a basket of Chinese corporate bonds. With housing sales down from previous years, lines of credit less available due to the Chinese Communist Party’s “three red lines” regulations, and demographic changes decreasing overall housing demand significantly in the coming years, many developers are likely to struggle to meet their on-book debt obligations, let alone the substantial off-book obligations in the form of pre-sales, employee borrowing, and delaying contractor payments. Worse still, with a lack of access to stable capital markets and paltry returns from banks, many private citizens have used housing as a vehicle to deliver returns, buying additional unfinished apartments with the goal of capitalizing on their appreciation later. The volatility causing this flight to real estate is partially driven by the CCP’s regulatory crackdowns on a variety of industries ranging from technology to education. For instance, a regulation requiring utilities to charge a fixed rate regardless of the fluctuating price of coal led to an energy crunch in September, with several power plants choosing to suspend operation rather than operate at a loss. Local authorities were pushed to resolve the issue at a regional level; left with few short-term solutions, many municipalities closed businesses to keep energy demands low. These and other disruptions have pushed investors to re-evaluate their risk assessment of Chinese markets – to many, the CCP’s commitment to its political goals has created structural issues for the Chinese economy. With China’s growth on the decline and its population expected to peak in 2027, the next few years will be crucial to determine the long-term trajectory of China’s prosperity.

The U.S. Has Some Catching Up to Do on Digital Currencies

Julia Friedlander and JP Schnapper-Casteras, World Politics Review

Read the full article here

While cryptocurrencies have shaken up financial markets with their promise of decentralized finance, their most far-ranging effect may ultimately be the development of central bank digital currencies (CBDC’s). More than eighty countries are currently researching, developing, or rolling out some form of CBDC, ushering in what is likely to be a new era of monetary flexibility and direct interaction between citizens and central banks. While CBDC’s are unlikely to unseat the dollar’s position as the currency of choice in today’s international financial system, the interactions between different payment systems as each government develops its own currency may segregate nations into de facto trading blocs if the systems do not interface well. China’s digital yuan is a prime example of this risk, as the CCP has already stated that foreign debt will be paid in its CBDC, and it seems likely that China will pressure participants in its Belt and Road Initiative to use the digital yuan. Still, broad adoption of the yuan would require implementing better international standards and liberalizing capital controls, two actions Beijing has been loath to take. Nonetheless, the appeal of CBDC’s is obvious in a techno-authoritarian system – the metadata of digital transactions are a gold mine for authoritarians seeking to increase their coercive power. These concerns are not absent from the CBDC conversation in the US either, with interest groups raising privacy concerns over a centralized digital currency. As with many elements of today’s society, digital currencies force lawmakers and citizens alike to make difficult decisions, weighing the benefits of CBDC’s (direct money supply control, reduction of overdraft fees, better access to the financial system, and greater transparency) against the costs (decreased anonymity in transactions, weakening of the current financial system, and the difficulty of implementation). Even as these conversations play out, the window of opportunity is closing. The US will need to act quickly if it is to take the lead in responsibly creating the next generation of digital currency.

Rising Temperatures Threaten Living Conditions for Billions

Climate change could bring near-unlivable conditions for 3bn people, say scientists

– Steven Bernard, Dan Clark, and Sam Joiner, Financial Times

At least 85 percent of the world’s population has been affected by human-induced climate change, new study shows

– Annabelle Timsit and Sarah Kaplan, The Washington Post

For thousands of years, humans have lived in a narrow average annual temperature band of 11C-15C (52F-59F), indicating that this climate niche is ideal for human survival and prosperity. According to a study conducted by Chinese, American, and European scientists and published by the Proceedings of the National Academy of Sciences of the USA (PNAS), each degree of warming above present levels corresponds to about one billion people falling outside of this climate band. Today, only 0.8% of the global land surface experiences mean annual temperatures beyond 29C (84.2 F), but this could quickly change if emissions continue to rise. Under the worst-case scenario set out by the Intergovernmental Panel on Climate Change (IPCC), if emissions continue to rise, 19% of the global land surface will experience mean annual temperatures above 29C by 2070, exposing a third of the projected world population to temperatures on par with the hottest areas of the Sahara Desert. The rising temperatures will disproportionately affect the global south: Africa, Latin America, and the Pacific. Unfortunately, this is also where there is a major deficit of climate research and investment in necessary technologies to quell climate change. Researchers at the Mercator Research Institute found that fewer than 10,000 studies looked at climate change’s effect on Africa, and only about 5,000 focused on South America. By contrast, there are roughly 30,000 published papers that analyze the climate impacts in North America. The discrepancy, known as an “attribution gap,” is due to a lack of capacity and funding for research in poorer countries and reflects researchers’ tendencies to highlight the priorities of wealthy nations. Research using machine-learning to analyze weather events suggests 85% of the world is experiencing human-induced climate impacts, but a much smaller portion of the world actually has the resources to deal with it.

Germany’s Economy, Once Europe’s Engine, Is Holding It Back

Tom Fairless, The Wall Street Journal

Read the full article here

Germany is struggling to re-assert itself as a robust export-oriented economy in the post-pandemic world which is rife with supply chain disruptions, rising energy prices, and geopolitical tensions. German manufacturers are struggling to produce cars as part and labor shortages abound and as demand for luxury cars wanes in the shift towards electric vehicles. The country’s industrial output in August fell 9% below 2015 levels whereas the rate of industrial output for the eurozone increased 2%, according to the European Union’s statistics agency. However, signs of the economy’s stagnation began emerging prior to the pandemic as industrial output and export data from 2017 shows. The country’s robust growth prior to 2017 was primarily driven by new markets, like China, and growing overseas demand. Now, China’s economy is not growing as fast and there is a global shift towards more localized production. This protectionist trend, which has been exacerbated by the pandemic and rising geopolitical tensions, could mean less export from Germany. The unease has business and political leaders considering whether the German economy needs a “reboot.”

The three parties negotiating a coalition government – the Social Democrats, the Green Party, and the Free Democrats – disclosed preliminary plans for “the biggest industrial modernization project that Germany has carried out in probably 100 years”, says the Social Democrats’ leader and likely next German chancellor, Olaf Scholz. As a part of their plan to overhaul the German economy, the three coalition parties also want to reduce government bureaucracy which is a major hurdle for new businesses and investment projects, costing German firms nearly fifty-five billion euros per year. The negotiating parties are also presenting the green transition as an economic opportunity, though many business groups and analysts say it will increase costs and endanger jobs. According to KfW, a state-owned development bank, Germany’s green transition will cost five trillion euros through 2045. Regardless of how the green transition is viewed, it will become a critical part of Germany’s future. CEO of Allianz, Oliver Baite, says “Germany’s entire business model is at stake…If we get energy transition wrong, our economic core gets into trouble and an economic crisis becomes inevitable.”