Macro Roundup

An Economist analysis suggests that if rates follow their current trajectory, total interest costs globally will rise from 12% of GDP in 2021 to 17% by 2027. Their analysis covered 58 countries representing 90% of global GDP, “…. The Economist has estimated the interest bill for companies, households and governments across 58 countries. Together these economies account for more than 90% of global GDP. In 2021 their interest bill stood at $10.4T, or 12% of combined GDP. By 2022 it had reached a whopping $13T, or 14.5% of GDP. Our analysis suggests that, if rates follow the path priced into government-bond markets, the interest tab will hit around 17% of GDP by 2027.Interest costs in America exceeded 20% of GDP during the global financial crisis of 2007-09, the economic boom of the late 1990s and the last proper burst of inflation in the 1980s. Yet an average bill of this size would mask big differences between industries and countries….”

Economist Staff, "The world’s interest bill is $13trn—and rising,"The Economist, February 19, 2023, https://www.economist.com/finance-and-economics/2023/02/19/the-worlds-13trn-interest-bill

The world’s interest bill is $13trn—and rising

After a relaxing 2010s, in which interest rates hardly budged, rising prices are putting central-bank officials to work. Indeed, policymakers have rarely been busier. In the first quarter of 2021, policy rates in a sample of 58 rich and emerging economies languished at an average of 2.6%. By the final quarter of 2022, this figure had jumped to 7.1%. Meanwhile, total debt in these countries stands at $298trn, or 342% of their combined gdp, up from $255trn, or 320% of gdp, before the covid-19 pandemic.

The more indebted the world becomes, the more sensitive it is to interest-rate rises. To assess the effect of borrowing and higher rates, The Economist has estimated the interest bill for companies, households and governments across 58 countries. Together these economies account for more than 90% of global gdp. In 2021 their interest bill stood at a $10.4trn, or 12% of combined gdp. By 2022 it had reached a whopping $13trn, or 14.5% of gdp.

Our calculations make a series of assumptions. In the real world, higher interest rates do not push up debt-servicing costs immediately, except for those of floating-rate debt, such as many overnight bank loans. The maturity of government debt tends to be in the range of five to ten years; companies and households tend to borrow on a shorter-term basis. Therefore we assume that interest-rate rises feed through over the course of five years for public debt, and over a two-year period for households and companies.

To project what might happen over the next few years, we make a few more assumptions. Real-life borrowers respond to higher rates by reducing debt to ensure that interest payments do not get out of hand. Nonetheless, research by the Bank for International Settlements, a club of central banks, shows that higher rates do raise interest payments on debt relative to income—ie, that deleveraging does not entirely negate higher costs. Thus we assume that nominal incomes rise according to imf forecasts and debt-to-gdp ratios stay flat. This implies annual budget deficits of 5% of gdp, lower than before covid.

Our analysis suggests that, if rates follow the path priced into government-bond markets, the interest tab will hit around 17% of gdp by 2027. What if markets are underestimating how much tightening central banks have in store? We find that another percentage point, on top of that which markets have priced in, would bring the bill to a mighty 20% of gdp.

Inflation may ease the burden somewhat by pushing up nominal tax revenues, household incomes and corporate profits. And global debt as a share of gdp has fallen from its peak of 355% in 2021. But this relief has so far been more than offset by the considerable rise in interest rates. In America, for instance, real rates as measured by the yield on the five-year Treasury inflation-protected security sit at 1.5%, against an average of 0.35% in 2019.

So who is bearing the burden? We rank households, companies and governments across our 58 countries according to two variables: debt-to-income ratios and the increase in rates over the past three years. When it comes to households, rich democracies, including the Netherlands, New Zealand and Sweden, look more sensitive to rising interest rates. All three have debt levels nearly twice their disposable incomes and have seen short-term government-bond yields rise by more than three percentage points since the end of 2019.

Yet countries that have less time to prepare for rate rises may, in fact, face greater difficulties than their more indebted peers. Mortgages in the Netherlands, for instance, often have longer-term fixed rates, meaning the country’s households are probably better protected from higher rates than our rankings suggest. In other countries, by contrast, households typically either have shorter-term fixed-rate loans or borrow on flexible terms. In Sweden floating-rate mortgages account for nearly two-thirds of the stock, which means problems may emerge more quickly. In emerging economies the data are patchier. Although debt-to-income ratios are lower, this partly reflects the fact that formal credit is hard to obtain.

Big debt burdens and tighter financial conditions may still prove too much for some companies. s&p Global, a research firm, notes that default rates on European speculative-grade corporate debt rose from under 1% at the start of 2022 to more than 2% by the end of the year. French firms are especially indebted, with a ratio of debt to gross operating profit of nearly nine, higher than any country bar Luxembourg. Russia, cut off from foreign markets, has seen short-term yields spike. Hungary, where the central bank has rapidly raised rates to protect its currency, could face a big interest bill relative to the size of its economy.

Last and most consequential is government debt. Daleep Singh of pgim, an asset manager, says a variable to watch is the risk premium on debt (the extra return markets demand to hold a country’s bonds over and above the yield on an American Treasury). Rich-world governments are mostly doing fine on this measure. But Italy, which has seen one of the biggest increases in bond yields among euro-zone countries in our sample, remains a risk. As the European Central Bank tightens policy, it has stopped buying sovereign bonds, and will begin to shrink its balance-sheet in March. The danger is that this prompts a crunch.

Emerging economies increasingly borrow in their own currencies, but those struggling with external debts may require help. Argentina recently reached a bail-out agreement, which will require uncomfortable belt-tightening, with the imf. It sits near the top of this category, and already defaulted on its external debt in 2020. Egypt, which has medium-term government-bond yields around four to five percentage points above pre-pandemic levels, is trying not to follow suit. Ghana, which recently joined Argentina in the severely distressed camp, is now embarking on fiscal and monetary tightening in an attempt to secure support from the imf.

The fate of some governments, as well as the households and firms that eventually need state support, may depend on the goodwill of China. Despite high debt levels, China itself sits near the bottom of our rankings because of its placid interest rates. Yet its importance to global debt stress is only growing. China is now the largest lender to the world’s poor economies and gobbles up two-thirds of their inflating external debt-service payments, complicating debt-relief efforts. Western governments must hope they can shoot down this balloon, too.

Money flowing into startups globally fell by a third in 2022 as valuations declined; however, there is still $300B of VC dry powder in the US alone.

“…The tech-heavy Nasdaq index fell by a third in 2022, making it one of the worst years on record and drawing comparisons with the dotcom bust of 2000-01. According to the Silicon Valley Bank, a tech-focused lender, between the fourth quarters of 2021 and 2022, the average value of recently listed tech stocks in America dropped by 63%. And the plunging public valuations dragged down private ones. The value of older, larger private firms (“late-stage” in the lingo) fell by 56% after funds marked down their assets or the firms raised new capital at lower valuations. What new VC funding there is increasingly flows into mega-funds. Data from PitchBook, a research firm, show that in America in 2022 funds worth more than $1bn accounted for 57% of all capital, up from 20% in 2018….”

Economist Staff, “How the titans of tech investing are staying warm over the VC winter,” The Economist, February 26, 2023, https://www.economist.com/business/2023/02/26/how-the-titans-of-tech-investing-are-staying-warm-over-the-vc-winter

How the titans of tech investing are staying warm over the VC winter

Venture capitalists are not known for their humility. But the world’s biggest investors in innovation have been striking a more humble tone of late. In a recent letter to investors Tiger Global, a hedge fund turned venture-capital (vc) investor, reportedly admitted that it had “underestimated” inflation and “overestimated” the boost the pandemic would give to the tech startups in its portfolio. In November Sequoia, a Silicon Valley vc blue blood, apologised to investors in its funds after the spectacular blow-up of ftx, a now defunct crypto-trading platform that it had backed. Speaking in January, Jeffrey Pichet Jaensubhakij, the chief investment officer of gic, one of Singapore’s sovereign-wealth funds, said that he was “thinking much more soberly” about startup investing.

The vc giants’ newfound contrition comes on the back of a gigantic tech crash. The tech-heavy nasdaq index fell by a third in 2022, making it one of the worst years on record and drawing comparisons with the dotcom bust of 2000-01. According to the Silicon Valley Bank, a tech-focused lender, between the fourth quarters of 2021 and 2022, the average value of recently listed tech stocks in America dropped by 63%. And the plunging public valuations dragged down private ones (see chart 1). The value of older, larger private firms (“late-stage” in the lingo) fell by 56% after funds marked down their assets or the firms raised new capital at lower valuations.

This has, predictably, had a chilling effect on the business of investing in startups. Soaring inflation and rising interest rates made companies whose promised profits lie primarily in the distant future look less attractive today. Scandals like ftx did not help. After a decade-long bull run, the amount of money flowing into startups globally declined by a third in 2022, calculates cb Insights, a data provider (see chart 2). In the final three months of 2022 it fell to $66bn, two-thirds lower than a year earlier; the number of mega-rounds, in which startups raise more than $100m, fell by 71%. Unicorns, the supposedly uncommon private firms valued at more than $1bn, became rarer again: the number of new ones contracted by 86%.

This turmoil is forcing the biggest venture investors—call them the vc whales—to shift their strategies. For Silicon Valley, it signals a reversion to a forgotten style of venture capitalism, with fewer deep-pocketed tourists splashing the cash and more bets on young companies by Silicon Valley stalwarts.

Misadventure capital

To understand the scale of vc’s reversal of fortune, consider its earlier bonanza. Between 2012 and 2021 annual global investments grew roughly ten-fold, to $638bn. Conventional vc firms faced competition from a new breed of investor from beyond Silicon Valley. These included hedge funds, the venture arms of multinational companies, from Shell to Samsung, and the world’s sovereign-wealth funds, some of which began investing in startups directly. Dealmaking turned frenetic. In 2021 Tiger Global inked almost one new deal a day. Across vc-dom activity “was a bit unhinged”, says Roelof Botha, boss of Sequoia Capital, “but rational”, given that low interest rates meant that money was virtually free. And “if you weren’t doing it, your competitor was.”

What passed for rationality in the boom times now looks somewhat insane. The downturn has spooked the vc funds’ main sources of capital—their limited partners (lps). This group, which includes everyone from family offices and university endowments to industrial firms and pension funds, is growing more nervous. And stingier: lower returns from their current investments leave lps with less capital to redeploy, and collapsing stockmarkets have left many of them overallocated to private firms, whose valuations take longer to adjust and whose share of some lps’ portfolios thus suddenly exceeds their quotas. Preqin, a data firm, finds that in the last quarter of 2022 new money flowing into vc funds fell to $21bn, its lowest level since 2015.

What new vc funding there is increasingly flows into mega-funds. Data from PitchBook, a research firm, show that in America in 2022 funds worth more than $1bn accounted for 57% of all capital, up from 20% in 2018. How the vc whales behind these outsize pools of capital adapt to the vc winter will determine the shape of the industry in the years to come.

The venture cetaceans can be divided into three big subspecies, each typified by big-name investors. The startups they finance range from the newly founded, in need of “seed” funding, to the somewhat older, later stage firms that are looking to rapidly grow. First there is the conventional Silicon Valley royalty, such as Sequoia and Andreessen Horowitz. The second group comprises the private tourists, such as Tiger and its New York hedge-fund rival, Coatue, as well as SoftBank, a gung-ho Japanese investment house. Then there are the sovereign-wealth funds, such as Singapore’s gic and Temasek, Saudi Arabia’s Public Investment Fund (pif) and Mubadala of the United Arab Emirates. As well as investing directly, these entities are lps in other vc funds; pif, for example, is a large backer of SoftBank’s Vision Fund.

Together these nine institutions ploughed more than $200bn into startups in 2021 alone, or roughly a third of the global total (not counting the state funds’ indirect investments as lps). All nine have been badly damaged by last year’s crash. Sequoia’s crossover fund, which invested in both public and private firms, reportedly lost two-fifths of its value in 2022. Temasek’s listed holdings on American exchanges shrank by about the same. SoftBank’s mammoth Vision Funds, which together raised around $150bn, lost more than $60bn, wiping out their previous gains. In a sign that things were terrible, its typically garrulous boss, Son Masayoshi, sat out its latest earnings call on February 7th. Tiger reportedly lost over half of the value of its flagship hedge fund and marked down its private investments by about a quarter, torching $42bn in value and leading one vc grandee to speculate that the hedge fund might turn itself into a family office.

All three groups have reined in their investments. But each has responded to the downturn in distinct ways. That is in part because it has affected them to different degrees.

The private outsiders have been hardest hit. The combined number of startup investments by the three firms in our sample fell by 76% between the second half of 2021 and the same period in 2022. Tiger has lowered the target for its latest fund from $6bn to $5bn; its previous one raised $13bn. In October Phillipe Laffont, Coatue’s boss, said that the hedge fund was holding 70-80% of its assets in cash. The firm has also raised $2bn for its “tactical solutions fund”, designed to give mature startups access to debt and other resources, as an alternative to raising equity at diminished valuations during a market downturn. SoftBank has all but stopped investing in new startups. Instead, in the second half of 2022 most of its capital went to well-performing portfolio firms, says Lydia Jett, a partner at the Vision Fund.

The other two groups are also retrenching, but not as drastically. According to data from PitchBook, in the second half of 2022 the number of deals struck by Sequoia and Andreessen Horowitz fell by a combined 47%. Direct investments by the four sovereign funds in our sample slowed by a more modest 31% in the same period, no doubt thanks to their governments’ deep pockets and longer time horizons.

Taken together, venture capitalists’ slowing pace of investment has left them with a record amount of capital that lps had already pledged to stump up but that has yet to be put to use. Last year the amount of this “dry powder” was just shy of $300bn in America alone (see chart 3). According to data from PitchBook, our five private whales are sitting on a combined $50bn or so; the sovereign investors hold their numbers close to their chest but are likely to be of a similar order of magnitude, all told. Some of it may wait a long while to be deployed, if it ever is. But some will find grateful recipients. Who those recipients are also depends on which group of whales you look at.

Conventional vcs and the hedge funds are focusing on younger “early-stage” firms. in part because volatility in the public markets makes it harder to value more mature companies that hope to list in the near future. Mr Botha says that Sequoia has doubled the number of “seed” deals with the youngest companies in 2022, compared with 2021. In January the firm launched its fifth seed fund, worth $195m. Last April Andreessen Horowitz launched an “accelerator” programme to nurture startups. About half the startups Tiger backed in 2022 were worth $50m or less, compared with just a fifth in 2021, according to PitchBook.

Early-stage firms are unlikely to be the only recipient of vc cash. David DiPietro, head of private equity at T. Rowe Price, a fund-management group, thinks that startups selling “must-have” products, such as cyber-security services, or cost-cutting tools, such as budgeting software, should fare well. Money will also keep flowing to well-managed businesses with strong balance-sheets., expects Kelly Rodriques, chief executive of Forge, a marketplace for private securities. Firms with buzzy new technologies, such as artificial-intelligence chatbots and other forms of whizzy “generative ai”, are also likely to attract investments—especially if those technologies already work in practice and underpin a viable business model.

Another category of startups likely to gain favour comprises those involved in industries that governments deem strategic. In America, that means climate-friendly technology and advanced manufacturing, on which Uncle Sam is showering subsidies and government contracts. Some 8% of the deals all our whales made in the second half of 2022 involved firms working on technologies to combat climate change, for example, up from 2% in the same period of 2021. Last year Andreessen Horowitz launched an “American Dynamism” fund, which partly invests in firms that rely on government procurement, such as Anduril, a defence-tech startup.

Sovereign-wealth funds are likely to be looking elsewhere. Seed deals are simply too small for them: whereas the typical early-stage American company is worth about $50m, in 2021 the median value of startups backed by the sovereign funds was a whopping $650m. And to them, what counts as “must-have” startups is somewhat different, determined less by the market or other states’ strategic imperatives, and more by their own governments’ nation-building plans.

On February 16th pif said it would take a stake in vspo, a Chinese platform for video-game tournaments. This is part of a plan dreamed up by Muhammad bin Salman, the Saudi crown prince, to invest $38bn in “e-sports” by 2030 and make Saudi Arabia a gamer’s mecca. Temasek invests heavily in firms that develop technology to boost food production. In the past year it backed Upside Foods, a startup selling lab-grown meat, and InnovaFeed, a maker of insect-based protein. This is motivated by Singapore’s goal of locally producing 30% of the city-state’s nutritional needs by 2030, up from about 10% in 2020. Rohit Sipahimalani, chief investment officer of Temasek, thinks that over the next few years his focus will shift towards “breakthrough innovation rather than incremental innovation”, on the back of government support of strategic tech.

One group of firms is likely to see less investment from our whales, however: those in China. The Communist Party’s harsh two-year crackdown on consumer technology may be easing but the vc titans remain wary of what was until recently one of the world’s hottest startup scenes. An executive at a big venture fund says that in the past, foreign investors in China knew that the government would be respectful of their capital. Now, he sighs, it feels like the government “has pulled the rug out from underneath us”.

Tiger has said that there is a “high bar” for new investments in China. gic has reportedly scaled back its investments in China-focused private funds. Mr Sipahimalani of Temasek says diplomatically that he is trying to avoid investing in “areas caught in the cross-hairs of us-China tension”. Sequoia is reportedly asking external experts to screen new investments made by its Chinese arm into quantum computing and semiconductors, two such contentious areas. All told, the number of our whales’ deals with Chinese startups fell from 22% of the total in 2021 to 16% in 2022.

After the dotcom crunch vc investments needed nearly two decades to return to their previous peak. Today’s tech industry is more mature, startups’ balance-sheets are stronger and, according to the Silicon Valley Bank, their peak valuations relative to sales are lower than in 2000-01. This time the whales of vc are unlikely to need 20 years to nurse their wounds. But the experience will have lasting effects on the sort of businesses they back.

China’s household savings rate was 33% in 2022, 3pp above the pre-pandemic trend, and big industrial companies added $1.1 trillion in liquid assets on average each year, more than double the $467 billion annual increase in the five years before Covid.

“…Chinese families, constrained by Covid lockdowns, hoarded cash and pushed up the country’s household saving rate to a multiyear high of 33% in 2022. Economists from HSBC and Morgan Stanley say the end of China’s strict zero-Covid policies will at minimum fuel a strong recovery in services spending, lifting consumption growth to at least its prepandemic rate of around 8% a year. A large portion of new deposits accumulated by Chinese households last year was locked up in three-year to five-year deposit instruments, which can’t as easily be converted into spending as short-term deposits can, according to a study by research firm Rhodium Group….”

Stella Yifan Xie, “Covid-Era Savings Are Crucial to China’s Economic Recovery,” Wall Street Journal, February 26, 2023, https://www.wsj.com/articles/covid-era-savings-are-crucial-to-chinas-economic-recovery-1ee3310b

Covid-Era Savings Are Crucial to China’s Economic Recovery

The strength of China’s economic rebound this year largely hinges on one uncertainty: whether families and large companies are willing to draw down the pile of cash they built up since the start of Covid-19.

Chinese families, constrained by Covid lockdowns, hoarded cash and pushed up the country’s household saving rate to a multiyear high of 33% in 2022, up 3 percentage points from the prepandemic trend in 2019, according to estimates by Goldman Sachs.

Large industrial companies and exporters also socked away money. From 2020 to 2022, big industrial companies, many state-owned, added $1.1 trillion in liquid assets on average each year, more than double the $467 billion annual increase in the five years before Covid hit, according to economists at China International Capital Corp., an investment bank.

In the U.S., excess savings—some from government stimulus—quickly coursed through the economy, but many experts wonder whether China will likewise have a big rebound in spending or investment this year.

Economists from HSBC and Morgan Stanley say the end of China’s strict zero-Covid policies will at minimum fuel a strong recovery in services spending, lifting consumption growth to at least its prepandemic rate of around 8% a year. Initial data from China’s recent Lunar New Year holiday suggest some Chinese consumers are eager to dine out and visit cinemas again.

Other economists feel more skeptical.

They argue that the savings buildup in China is more a reflection of battered confidence, which is unlikely to be reversed quickly as pains from the pandemic linger. Many Chinese consumers remain nervous because of a depressed housing market and an uncertain jobs picture, which could make them save more and spend less for longer.

“It is premature to conclude that excess savings accumulated by households will support revenge spending in a persistent way,” said David Wang, chief China economist at Credit Suisse.

A slow consumption rebound in China could reverberate globally, damping sales for such companies as Nike Inc., Starbucks Corp. and international auto makers, and resulting in lower-than-expected demand for such commodities as copper and nickel. Many businesses are counting on China, which is projected to account for a third of global growth this year as growth in the U.S. and Europe slows, according to the International Monetary Fund.

Swelling household savings helped push China’s current-account surplus to $417.5 billion last year, the highest level since 2008, underscoring just how entrenched the global trade imbalance has been even as the U.S. and other more-advanced economies attempt to reduce reliance on Chinese imports.

It isn’t clear exactly how big China’s savings pile is. Many economists, concerned about data quality in China, use different methods for their calculations.

Goldman Sachs says it believes Chinese families accumulated about three trillion yuan, equivalent to roughly $431 billion, in excess savings, or less than 3% of China’s gross domestic product, from 2020 to 2022. Economists from Nomura and UBS put the figures higher, at 6.1 trillion yuan and up to 4.6 trillion yuan, respectively, or about 5% and close to 4% of GDP in 2022.

While sizable, those figures are lower than in the U.S., where households put away $2.3 trillion in excess savings from 2020 through September 2021, or nearly 10% of GDP in 2021, according to a study published by the Federal Reserve.

A large portion of new deposits accumulated by Chinese households last year was locked up in three-year to five-year deposit instruments, which can’t as easily be converted into spending as short-term deposits can, according to a study by research firm Rhodium Group.

Given that China’s government refrained from handing out checks directly to households during the pandemic, it could take a while before people become more confident in China’s recovery and significantly scale back their saving, said Tao Wang, an economist at UBS.

More relevant to consumers’ spending appetite, economists say, are income growth and the job market, both of which are recovering slowly.

Zhou Changtian, who works at a state-owned publishing house in Shanghai, ended up saving more during the past three years as his family wasn’t able to travel abroad. Even though he isn’t deeply worried about job security, he isn’t keen on splurging, partly because of inflation fears as the economy reopens.

“It used to cost us 1,000 yuan [about $145] to stock up on meat in the fridge before Covid. Now we have to pay double,” said Mr. Zhou. “I definitely won’t go on a spending spree.”

Some companies are loosening their purse strings in anticipation of a strong economic recovery. Several industrial companies in China have announced big-ticket projects, including Ganfeng Lithium—one of the world’s largest refiners of strategic metal—which last month unveiled a 15 billion yuan ($2.2 billion) investment to build two battery plants in China.

But Larry Hu, chief China economist at Macquarie Group, is cautious about whether corporations have strong incentives to spend. He expects overall capital expenditure to stay flat compared with last year, in part because of uncertainty at export-oriented companies as overseas demand has weakened.

Another concern: Even though big companies were able to put away money by delaying investments during the pandemic, many smaller Chinese businesses, lacking deep pockets, had to spend savings to survive. Many are still on the ropes—or wiped out entirely.

Beijing restaurant operator Nathan Zhang said he hasn’t been able to repay food and wine suppliers at a bistro he owns, because it was forced to shut down or banned from offering dine-in services several times under Covid restrictions. Even though those restrictions have ended, Mr. Zhang estimates that he has lost about 10% to 20% of his regular clientele.

“While we still harbor hope that the worst is behind us, there are still too many uncertainties,” he said.