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Monthly Archives: April 2017

The German government ends and the auto industry

Daimler and Volkswagen’s top lobbyists were once close aides to Chancellor Angela Merkel. The foreign minister, Sigmar Gabriel, used to sit on Volkswagen’s supervisory board. Ms. Merkel herself once buttonholed the governor of California to complain about the state’s strict emissions standards.

Those close relations between public officials and car manufacturers were once considered vital economic policy for Germany’s most important export. Now, they are a political liability.

Weeks before national elections, voters increasingly see the government as complicit with carmakers in a widening diesel crisis that threatens the German economy. While Ms. Merkel is still heavily favored to win, the chancellor and her political rivals consider the automakers toxic and have begun to distance themselves from them.

The backlash has been building since 2015, when United States regulators uncovered widespread emissions cheating by Volkswagen, Europe’s largest automaker. The broadening case, which has also ensnared BMW and Daimler, has called attention to the harmful effects of nitrogen oxide emissions from diesel vehicles. Cities across Europe are considering diesel bans, and sales of diesel engines are plummeting.

For decades, the German government has been a crucial ally for carmakers, operating as a de facto lobbyist for the industry.

With the active support of officials, automakers used their political clout in Brussels to block stricter emissions regulations and to promote subsidies for diesel. German leaders, including Ms. Merkel and her predecessor, argued against tough emissions rules and pushed for better terms for the country’s carmakers abroad.

Most recently, Germany led a group of auto-producing countries in weakening European emissions testing procedures that were designed to prevent the kind of deception committed by Volkswagen. New cars must pass road tests. Previously, they had to pass only laboratory exams, which Volkswagen and other carmakers were able to game. But, at German insistence, cars can emit double the legal limit of nitrogen oxides and still be approved.

German political leaders and automakers have worked together to promote diesel technology since the 1990s. Ms. Merkel’s predecessor, Gerhard Schröder, was proud to be known as the “auto chancellor.”

Germany has taxed diesel fuel at a lower rate than gasoline since the 1980s, originally to make truck transport, which is predominantly diesel, less expensive. The goal, according to a 2011 study by Transport and Environment, an advocacy group in Brussels, was to lower costs to help German manufacturers compete internationally.

In the 1990s, the auto industry preserved the subsidies by convincing politicians that diesels were better for the environment than gasoline engines, a dubious claim given the other pollutants that diesel spews. For years, environmentalists’ calls to raise diesel taxes have met opposition from the country’s largest political parties, including Ms. Merkel’s Christian Democrats.Backlash against automakers has been building since 2015, when United States regulators uncovered widespread emissions cheating by Volkswagen, Europe’s largest automaker.CreditCarsten Koall/European Pressphoto Agency

 Those tax breaks have ensured that diesel is significantly cheaper at the pump, leading to a steady rise in the popularity of diesel-powered cars. Until recently, they outsold their gasoline-powered counterparts around Europe.

German carmakers and politicians engaged in a similar battle in Brussels, fighting for years to bat away tougher emissions rules. In 2013, Germany used its clout as the European Union’s largest economy to intervene when the bloc’s executive arm wanted to tighten limits on carbon dioxide emissions.

Matthias Wissmann, head of the German Association of the Automotive Industry and a former transportation minister, wrote a letter to Ms. Merkel, warning that the new standards would hurt sales of German luxury cars. In that letter, he addressed Ms. Merkel as “du,” the informal German word for “you” normally used only between close friends.

Ms. Merkel then personally called Prime Minister Enda Kenny of Ireland, who held the rotating presidency of the European Council, and persuaded him to delay a decision. The standards were eventually watered down.

German leaders campaigned for carmakers farther afield, too. On a trip to California in 2010, Ms. Merkel complained about the state’s strict limits on nitrogen oxides during a meeting with Gov. Arnold Schwarzenegger.

“She said, ‘Your nitrogen oxide limits are too strict, and that is hurting our German diesels,’” Mary Nichols, the chairwoman of the California Air Resources Board and an attendee at the meeting, said in testimony to the German Parliament in March. “She was there, it seemed, as spokeswoman for the auto industry.”

Stephan Weil, prime minister of Lower Saxony, home of Volkswagen, conceded in August that he had allowed company lobbyists to vet a 2015 speech about the emissions deception. The state of Lower Saxony owns a 20 percent stake in Volkswagen, and Mr. Weil sits on the carmaker’s supervisory board.

Mr. Weil, a member of the Social Democrats, denied making significant changes to the speech after it was shown to Volkswagen. Thomas Steg, head of government relations for the carmaker, said Volkswagen looked only for factual errors.

The case, first reported by the newspaper Bild am Sonntag, helped spur a turnaround in public perceptions of diesel, once a point of national pride.

The diesel engine, like the automobile, was a German invention, and the country’s carmakers leveraged their know-how to achieve dominance in the European luxury car market. The auto industry, including suppliers, currently employs about 2 percent of the German work force, according to Commerzbank.

Against that backdrop, deep political ties were forged.

German carmakers have often recruited government insiders to represent their interests. Mr. Steg of Volkswagen was once a spokesman for Ms. Merkel. Eckart von Klaeden, responsible for Daimler’s relations with governments worldwide, served under her as a junior minister.

All of the country’s main parties, even the environmentalist Greens, have long histories of amiable relations with the auto industry. Joschka Fischer, a former foreign minister who for many years was standard-bearer for the Greens, now works as a consultant to BMW, though the carmaker says he does not do any lobbying.

While money plays a much smaller role in election campaigns in Germany than in the United States, the auto companies nevertheless make their presence known. Daimler, for example, contributed 100,000 euros, or about $120,000, each to Ms. Merkel’s party and to the Social Democrats, according to documents filed at the German Parliament. The carmakers also help to finance party events and loan cars for free to elected officials, activities that they are not required to disclose.

BMW said in a statement that it had tightened its rules on interactions with politicians, ensuring, for example, that parties report the use of vehicles as a financial contribution. Daimler did not respond to a request for comment.

Mr. Steg, the Volkswagen lobbyist and former aide to Ms. Merkel, said a close relationship between carmakers and politicians was of common interest. Others argue that lobbying helps auto executives understand the workings of government, and public officials understand the car business.

Since the end of World War II, Mr. Steg said, “politicians have always had a huge interest in the well-being of the industry and the creation of jobs.”

The government’s own study last year showed that virtually all makers of diesel cars had flouted emissions limits, but Ms. Merkel’s ministers did not impose penalties. Germany now faces a lawsuit by the European Commission over failures to enforce the bloc’s clean air rules.

China-backed investor from buying an American

On Wednesday blocked a China-backed investor from buying an American semiconductor maker over national security concerns, a rare move that could signal more aggressive scrutiny of China’s deal-making ambitions.

The deal for Lattice Semiconductor has provided a test of the president’s economic and diplomatic relationship with China.

On the campaign trail, Mr. Trump reserved some of his harshest words for China, accusing the country of stealing jobs. In recent months, the president has turned more critical of Beijing, accusing it of failing to do more to restrain the nuclear ambitions of North Korea.

Derek M. Scissors, a resident scholar at the American Enterprise Institute who studies Chinese investment, said that the administration’s decision over Lattice was intended to send a political message. “We could let it die quietly,” he said, “but we’re going to kill it loudly.”

The White House said on Wednesday that it prevented the acquisition of Lattice Semiconductor, in part because the United States government relies on the company’s products. The integrity of the semiconductor industry, it said, was vital.

The White House also raised concerns over the buyer’s close ties to Beijing. The investment group included China Venture Capital Fund Corporation, which is owned by state-backed entities, the White House said.

The decision could foretell trouble for other Chinese deals under review by the Committee on Foreign Investment in the United States, a multiagency group that examines takeovers of American companies by foreign buyers and makes recommendations to the president. The group, which operates largely in secrecy, is also looking at the proposed purchase of MoneyGram International by Ant Financial, an affiliate of the Chinese technology giant Alibaba Group.

Chinese deal-making in the United States has surged in recent years, as cash-rich companies look overseas to diversify and spread their wealth. Last year, Chinese investment hit $46 billion, a threefold increase from 2015 before, according to the research firm Rhodium Group.

The flow of Chinese money into the country, although it has slowed lately, has prompted concerns over the state’s influence in corporate strategy. Critics are particularly worried that China is focusing on sensitive industries, like technology. White House officials and lawmakers on both sides of the aisle are pushing for new rules that would keep closer tabs on deals by foreign buyers, by expanding the powers of the foreign investment committee, known as Cfius.

Mr. Trump has sought to take a tough line on China’s trade and investment practices, threatening on the campaign trail to enact sweeping tariffs. Although his moves in office have so far been more modest, he has stoked tensions between the two countries.

In August, the White House began an investigation into claims of Chinese violations of American intellectual property, an inquiry that could result in tariffs or another negotiated outcome. Mr. Trump also called for a report on the steel industry, where China is dominant.

By blocking the deal for Lattice Semiconductor, the president is taking direct aim at China’s industrial policy.

As China looks to expand its global reach and support its economic growth, the government wants to be a dominant force in cutting-edge industries. The country’s “Made in China 2025” program, which will provide extensive assistance and cheap loans to certain industries, lays out an ambitious plan to build homegrown giants that will compete with American stalwarts.

Semiconductors has been a major focus of the effort. As China moves to build and design chips, Chinese investors has acquired overseas chip makers and teamed up with Western technology giants.

The deal for Lattice Semiconductor played to those ambitions.

The company announced an agreement last November to sell itself to a private equity firm, Canyon Bridge Capital Partners, for $1.3 billion. The initial funding for the firm, based in Palo Alto, Calif., came from China.

Cfius raised warning flags about the deal. Although the review process takes place behind closed doors, Lattice disclosed on Sept. 1 that the committee planned to recommend that the president to block the deal.

When that happens, companies usually drop their acquisition plans. Last year, Philips, the Dutch electronics giant, called off a deal to sell a big stake in its automotive and LED components business over Cfius concerns. The buyer was a consortium with GO Scale Capital, an investment fund sponsored, in part, by GSR Ventures of China.

Digital Fortune in China

Today, many have found it at a place that makes money — the digital kind.

Here, in what is locally called the Dalad Economic Development Zone, lies one of the biggest Bitcoin farms in the world. These eight factory buildings with blue-tin roofs account for nearly one-twentieth of the world’s daily production of the cryptocurrency.

Based on today’s prices, it issues $318,000 in digital currency a day.

From the outside, the factory — owned by a company called Bitmain China — does not look much different from the other buildings in the industrial park.

Its neighbors include chemical plants and aluminum smelters. Some of the buildings in the zone were never finished. Except for the occasional coal-carrying truck, the roads are largely silent.

Inside, instead of heavy industrial machinery, workers tend rows and rows of computers — nearly 25,000 computers in all — crunching the mathematical problems that create Bitcoin

 Workers carry laptop computers as they walk the aisles looking for breakdowns and checking cable connections. They fill water tanks that keep the computers from melting down or bursting into flame. Around them, hundreds of thousands of cooling fans fill the building with whooshing white noise.

Bitcoin’s believers say it will be the currency of the future. Purely electronic, it can be sent across borders anonymously without oversight by a central authority. That makes it appealing to a diverse and sometimes mismatched group that includes tech enthusiasts, civil libertarians, hackers and criminals.

Bitcoin is also, by and large, made in China. The country makes more than two-thirds of all Bitcoin issued daily. Bitmain, founded by Jihan Wu, a former investment analyst, makes money mostly by selling equipment to make Bitcoins, as well as mining the currency itself.

China has mixed feelings about Bitcoin.

On one hand, the government worries that Bitcoin will allow Chinese people to bypass its strict limits on how much money they can send abroad, and could also be used to commit crimes. Chinese officials are moving to close Bitcoin exchanges, where the currency is bought and sold, though they have not set a time frame. While that would not affect Bitcoin manufacturing directly, it would make buying and selling Bitcoin more expensive in one of its major markets, potentially hurting prices.

On the other hand, the digital currency may represent an opportunity for China to push into new technologies, a motivation behind its extensive push into other cutting-edge areas, like driverless cars and artificial intelligence. China continues to offer Bitcoin makers like Bitmain cheap electricity — making Bitcoin requires immense amounts of power — and other inducement

Dalad Banner may be far away from Beijing’s internet start-up scene and southern China’s gadget hub. Still, many of the workers and surrounding residents see a digital opportunity for Dalad Banner and the rest of their part of Inner Mongolia, an area famous in China for half-finished factories and towns so empty that they are sometimes called ghost cities.

“Now the mine has about 50 employees,” said Wang Wei, the manager of Bitmain China’s Dalad Banner facility, using one of several metaphors for the work being done there. “I feel in the future it might bring hundreds or even thousands of jobs, like the big factories.”

Mr. Wang, a 36-year-old resident and former coal salesman, purchased one Bitcoin about six months ago. It has since more than doubled in value. “I made quite a lot of money,” he said.

China also sees a potential new source of jobs, particularly in underdeveloped places like Dalad Banner. The county of about 370,000 people on the edge of the vast Kubuqi Desert boasts coal reserves and coal-powered heavy industries like steel. But it lags behind much of the rest of the country in broadly developing its economy. It is part of the urban area of Ordos, a city about 350 miles away from Beijing famousfor its empty buildings.

A Trader Is Betting Millions on It

Mr. Cole, who opened Artemis Capital to outside investors in 2012, is taking the opposite side, arguing with the passionate intensity of the true believer that this market calm cannot last.

In doing so, he draws parallels to the stock market crash of 1987, when investors were similarly lulled into believing that volatility would not erupt.

So far, those betting against chaos have carried the day.

After peaking at close to 90 at the time of the financial crisis, the VIX recently sank to a multidecade low of just below 9, the occasional sharp spike upward notwithstanding. (As of Wednesday afternoon, it was 10.5.)

Several factors have helped along the way, analysts say. They include aggressive money printing and bond purchasing by global central banks and the profusion of exchange traded investments, which make it cheap and easy for professionals and amateurs alike to bet on a falling VIX.

Now, just a month ahead of the 30th anniversary of Black Monday, when the Standard & Poor’s 500 stock index plunged 20 percent, Mr. Cole is wagering on a similar calamity, underpinned by a vicious spike in the VIX and a steep sell-off in stocks.

“The fact that everyone has been incentivized to be short volatility has set up this reflexive stability — a false peace,” he said. “But if we have some sort of shock to the system, all these self-reflexive elements reverse in the other direction and become destabilizing as opposed to stabilizing.”

Calling an end to the second-longest bull market in modern financial history has, understandably, become quite fashionable. Not just on the perma bear fringes, either. Wall Street houses talk regularly about overvalued stock markets, and establishment voices like Lloyd C. Blankfein, the chief executive of Goldman Sachs, have mused openly that “things have been going up for too long.”

A little-known British investment firm, Ruffer Capital, has caused a stir by predicting a shattering denouement, and many hedge funds are buying up cheap VIX options, which will pay off handsomely if the index shoots up.

Artemis Capital is of a slightly different stripe. It is, as Mr. Cole likes to say, a hedge fund with a capital H. That means, in times of bull market fever, the fund will bet on a reversal, offering downside protection for cautious investors by finding creative ways to purchase exposure to financial chaos. These trades entail purchasing a variety of derivative instruments that pay off if there is a dramatic upward spike in the VIX, which can cause stocks to fall precipitously.

Of late, money managers seeking such a hedge have grown markedly. Mr. Cole, who started with $1 million in 2012, is now sitting on $200 million, and demand has been so strong recently that he expects to hit $300 million soon, at which point he will restrict further access.

Mr. Cole, 38, has the bouncy enthusiasm of a young child, and he spends each waking day reading, coding and free associating about what it will be that marks the bull market’s end.

Like many dyed-in-the-wool market skeptics, he has his quirks. To remind himself to make full use of each day, he wears a watch that counts off the time he has left to live — 50 years and 4 months.

At the moment, Mr. Cole calculates that as much as $1.5 trillion in investor money is betting the markets will remain as they more or less have been since 2009: volatility free.

This sum, he says, includes about $60 billion in funds that are explicitly short volatility in its many forms. The bulk of this amount is in funds that deploy strategies where volatility is a critical input for allocating exposure to the stock market. So the lower volatility is, the more these funds load up on stocks.

Piling on to the low volatility trade have been corporations, which this year may buy back close to $1 trillion worth of stock, analysts estimate.

In 1987, portfolio insurance transformed a market decline into a historic rout when computer driven programs sold stock market futures into a panicked marketplace absent of willing buyers. Mr. Cole says this $1.5 trillion in short volatility money can play a similar role today if the fear gauge index spikes sharply.

All of a sudden VIX sellers will become VIX buyers, which will send the index soaring and stocks plummeting.

As he sees it, the formulaic strategies that sold stock market futures into a falling market in 1987 and the short volatility money of today are akin to barrels of petroleum that can turn a mere fire into a seismic conflagration.

“In 1987, we were in a bull market, and the Fed was behind the curve with regard to inflation and interest rates,” Mr. Cole said. “What could cause a crisis now is if rates suddenly spike higher, share buybacks seize up and then the volatility sellers turn into volatility buyers all at once.”

It is, in many ways, a moral argument for him.

Volatility sellers reap cheap and fleeting gains, which he compares to speeding, obesity and marrying for money. Those willing to suffer the immediate pain of being long volatility — before the reward of calamity comes — Mr. Cole sees as being more virtuous.