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America and the EU are both toughening up on foreign capital

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“DEAR Donald, let’s remember our common history,” wrote Jean-Claude Juncker, the president of the European Commission, on a picture of a military cemetery in Europe that he presented to President Donald Trump during talks on July 25th. The reminder of shared values and sacrifices may have helped nudge the two men towards a truce in the incipient transatlantic trade war (see article). That truce will help America and Europe to co-operate on another front.

Both suspect that investment from China is a ploy to gain access to advanced technology and undermine domestic security. European officials are thrashing out the details of an EU-wide investment-screening mechanism, proposed by Mr Juncker in 2017. A government white paper on national security and investment published on July 24th suggests that post-Brexit Britain will be no soft touch, either: it was widely seen as intended to increase scrutiny of Chinese buyers. But it is the Trump administration that is moving fastest.

Mr Trump had considered raising barriers to Chinese inward investment in sectors targeted by the “Made in China 2025” development policy. But he decided instead to support a plan to strengthen an existing investment-screening mechanism, the Committee on Foreign Investment in the United States (CFIUS). With votes in both houses of Congress expected shortly, and bipartisan support, he could soon be signing it into law.

CFIUS is already powerful. If it thinks a deal threatens national security, it can propose remedies or recommend that the president blocks the transaction. But security threats have evolved since it was set up in 1975, says Heath Tarbert, assistant secretary of the Treasury. The line between commercial and defence technologies has blurred, and the explosion in personal data has created new vulnerabilities. CFIUS’s workload has more than doubled in a decade. Lawyers complain that even uncontroversial deals are being held up.

The Foreign Investment Risk Review Modernisation Act would give CFIUS greater authority to examine deals where foreign investors gain control of critical infrastructure or technology, or of personal data. Minority investments would be covered if they give investors access to sensitive information. It allows for CFIUS’s budget to be increased. And it tightens export-control rules, which prevent sensitive technology being transferred abroad.

Early drafts were seen by businesses and former CFIUS officials as too draconian. Lawmakers have been surprisingly willing to listen to critics, and unusually bipartisan, says Kevin Wolf, a former assistant secretary to the commerce department under Barack Obama. The latest version should, he reckons, give businesses more clarity on the kinds of technology that will come under CFIUS review.

Other aspects are hazier. Without further regulations, businesses that store personal data may not always know if their deals need review. CFIUS’s remit will expand to include more small firms receiving early-stage investment. Reviews are costly, since would-be buyers and sellers usually hire lawyers and CFIUS is to be allowed to start charging fees. Some fret that the costs could put startups off foreign investment.

Although the new rules set out the kinds of deals that should be scrutinised, CFIUS alone decides if a deal poses a security risk. Among its members are officials from both security-oriented defence and justice agencies, and business-facing departments such as commerce and treasury. That split used to allow CFIUS both to protect national security and to promote foreign investment, says Clay Lowery, a former assistant secretary of the Treasury. Under Mr Trump, though, the economic protectionists now line up alongside the security hawks.

Investment from China has already fallen (see chart). That partly reflects capital controls and crackdowns on dealmaking back home. CFIUS blocked several high-profile deals in the past year, and Mr Trump’s threats on trade and investment will not have helped.

Flows of capital to Europe have held up a bit better. But it too is becoming less welcoming to Chinese investment. Mr Juncker’s proposals, which officials are hoping to finalise by the end of the year, would allow EU countries to share information on the national-security impact of foreign deals. With the tough guys in charge in America and Europe, Chinese investors may have to look elsewhere.

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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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