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A banking centre seeks to reinvent itself

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ON A clear day, sunset over Lake Zug is magnificent. Snow-dusted mountains cut through the orange glow above and are mirrored in the lake below. “Zug is our spiritual home,” says Jeremy Epstein, from Washington, DC, who has just taken 40 foreigners to tour the small Swiss town south of Zurich. They came not for sunsets, though, but to find out how Zug has become known as “crypto-valley”—meaning the home of many firms dealing in crypto-currencies and related activities.

Switzerland’s famous banking secrecy is falling to a global assault on money-laundering and tax evasion. But financial security remains in demand. The country should seek to become the “crypto-nation”, said the economy minister, Johann Schneider-Ammann, last month. Zug aims to be the capital of that nation.

To that end, Switzerland is maintaining loose rules for crypto-businesses, even as other countries are tightening theirs. An industry is developing to store tangible crypto-assets, such as the hard drives on which cryptographic keys are stored, offline in cold, dry, secret sites complete with rapid-response teams. Where better than a decommissioned military bunker in the Swiss Alps? In Zug, friendliness to crypto-currencies is in evidence all around. “Bitcoin accepted here” stickers adorn the city hall and several shops, including the wine merchant’s. In 2016 Zug became the first place in the world to accept bitcoin for some public services. Residents can get a blockchain-based digital identity.

About a quarter of last year’s global total of $5bn in initial coin offerings (ICOs, a form of crowdfunding whereby investors are issued with digital tokens) was raised in Switzerland, estimates PwC, a consultancy. Of the ten largest ICOs, four were in part based in Zug.

The town decided early on to attract crypto-entrepreneurs, for example by allowing companies to incorporate based on bitcoin wealth, rather than insisting that it be converted into fiat currency. Taxes have long been low. After the second world war the former fishing village cut its corporate-tax rate to 8.5%. The rate is still competitive, at 14.6% compared with Zurich’s 21%.

Snowball effect

The crypto-chapter of Zug’s history began in earnest in 2013 when the Ethereum Foundation, a non-profit to support the development of the eponymous blockchain, based itself there. More crypto-firms followed. Now, having dealt with 150-odd of them, the local tax authorities are experts, as are the accountants and lawyers.

Two years ago Lakeside Partners, which runs a business centre in Zug, housed just five blockchain-related companies, of a total of 30. Now the number is 70 out of 90. “They landed like flying saucers,” says the mayor, Dolfi Mueller. At first he was unsure that the invaders would benefit the town, but “curiosity and being open to the world have brought us much wealth in the past.”

Switzerland’s decentralised government, direct democracy and history of libertarianism are all essential to Zug’s success. These contrast with rival hubs such as Hong Kong and Singapore, and appeal to fans of blockchain technology, which underlies most crypto-currencies and is essentially a distributed ledger maintained collectively by some users. There are practical benefits for crypto-entrepreneurs, too. The federal government takes a light approach to regulation in general, and to new technologies in particular. Cantons have wide latitude in how they deal with companies. A fintech licence, expected to become available next year, should make life even easier for fintech startups.

A final draw is a reputation for security and safety—including from governments. “You can have all the armoured walls in the world, but if your vault is in China or Singapore and the government says, ‘I’m seizing your assets’, there’s nothing you can do,” says Niklas Nikolajsen of Bitcoin Suisse, a financial-services provider. “That would never happen in Switzerland.”

Regulators elsewhere see it as their job to protect consumers from dubious new crypto-currencies. But Switzerland’s take a more bracing approach. “Our consumers should have the freedom to invest in exotic instruments, even gamble,” says one official. Jörg Gasser, the state secretary for international finance, has little doubt that, if and when the bitcoin bubble bursts, investors will ask for regulation. But, he says, the sector must not be regulated to death.

That does not mean anything goes. His priority, says Mr Gasser, is to protect the integrity of Switzerland as a financial centre. The national regulator, FINMA, is investigating several ICOs for possible breaches of regulations, including anti-money laundering rules. On February 16th it issued guidance on how it would apply existing market legislation, and warned that some tokens would be treated as securities and have to follow stricter rules. A working group has been assembled to look at which rules, if any, ought to apply to ICOs. The aim is to increase legal certainty and ensure that, in the words of a press release from the State Secretariat for International Finance, a government department, “Switzerland remains an attractive location in this area.”

Crypto-entrepreneurs took the measured tone as indicating that Switzerland is still keen on their business. Indeed, as the sector matures, places that offer some regulatory protection or licensing should benefit, says Joey Garcia, a lawyer at Isolas LLP, who has just helped develop a licensing system in Gibraltar, a rival crypto-centre.

While crypto-companies are growing, physical hubs with well-crafted rules and a critical mass will continue to seem attractive. But crypto-currencies’ intrinsically decentralised nature means that eventually the benefits of being part of a cluster may weaken. Unless Zug continues to court them, only the vaults carved into the Swiss granite will stand the test of time.

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Japan still has great influence on global financial markets

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IT IS the summer of 1979 and Harry “Rabbit” Angstrom, the everyman-hero of John Updike’s series of novels, is running a car showroom in Brewer, Pennsylvania. There is a pervasive mood of decline. Local textile mills have closed. Gas prices are soaring. No one wants the traded-in, Detroit-made cars clogging the lot. Yet Rabbit is serene. His is a Toyota franchise. So his cars have the best mileage and lowest servicing costs. When you buy one, he tells his customers, you are turning your dollars into yen.

“Rabbit is Rich” evokes the time when America was first unnerved by the rise of a rival economic power. Japan had taken leadership from America in a succession of industries, including textiles, consumer electronics and steel. It was threatening to topple the car industry, too. Today Japan’s economic position is much reduced. It has lost its place as the world’s second-largest economy (and primary target of American trade hawks) to China. Yet in one regard, its sway still holds.

This week the board of the Bank of Japan (BoJ) voted to leave its monetary policy broadly unchanged. But leading up to its policy meeting, rumours that it might make a substantial change caused a few jitters in global bond markets. The anxiety was justified. A sudden change of tack by the BoJ would be felt far beyond Japan’s shores.

One reason is that Japan’s influence on global asset markets has kept growing as decades of the country’s surplus savings have piled up. Japan’s net foreign assets—what its residents own abroad minus what they owe to foreigners—have risen to around $3trn, or 60% of the country’s annual GDP (see top chart).

But it is also a consequence of very loose monetary policy. The BoJ has deployed an arsenal of special measures to battle Japan’s persistently low inflation. Its benchmark interest rate is negative (-0.1%). It is committed to purchasing ¥80trn ($715bn) of government bonds each year with the aim of keeping Japan’s ten-year bond yield around zero. And it is buying baskets of Japan’s leading stocks to the tune of ¥6trn a year.

Tokyo storm warning

These measures, once unorthodox but now familiar, have pushed Japan’s banks, insurance firms and ordinary savers into buying foreign stocks and bonds that offer better returns than they can get at home. Indeed, Japanese investors have loaded up on short-term foreign debt to enable them to buy even more. Holdings of foreign assets in Japan rose from 111% of GDP in 2010 to 185% in 2017 (see bottom chart). The impact of capital outflows is evident in currency markets. The yen is cheap. On The Economist’s Big Mac index, a gauge based on burger prices, it is the most undervalued of any major currency.

Investors from Japan have also kept a lid on bond yields in the rich world. They own almost a tenth of the sovereign bonds issued by France, for instance, and more than 15% of those issued by Australia and Sweden, according to analysts at J.P. Morgan. Japanese insurance companies own lots of corporate bonds in America, although this year the rising cost of hedging dollars has caused a switch into European corporate bonds. The value of Japan’s holdings of foreign equities has tripled since 2012. They now make up almost a fifth of its overseas assets.

What happens in Japan thus matters a great deal to an array of global asset prices. A meaningful shift in monetary policy would probably have a dramatic effect. It is not natural for Japan to be the cheapest place to buy a Big Mac, a latté or an iPad, says Kit Juckes of Société Générale. The yen would surge. A retreat from special measures by the BoJ would be a signal that the era of quantitative easing was truly ending. Broader market turbulence would be likely. Yet a corollary is that as long as the BoJ maintains its current policies—and it seems minded to do so for a while—it will continue to be a prop to global asset prices.

Rabbit’s sales patter seemed to have a similar foundation. Anyone sceptical of his mileage figures would be referred to the April issue of Consumer Reports. Yet one part of his spiel proved suspect. The dollar, which he thought was decaying in 1979, was actually about to revive. This recovery owed a lot to a big increase in interest rates by the Federal Reserve. It was also, in part, made in Japan. In 1980 Japan liberalised its capital account. Its investors began selling yen to buy dollars. The shopping spree for foreign assets that started then has yet to cease.

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