Reading worth investing in: Japan’s trilemma, China Big Tech goes all in on AI and why a wealth tax is no quick fix
Links for the weekend: investment trust discounts narrow, the kids get AI, all global cities rated with Geneva tops for post-tax and rent salary, and those dismal UK GDP numbers explained
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Programming note: As we head into the summer, I’ll be taking a few weeks off or switching to weekly notes (through to the end of August). Next week I’ll be switching to a weekly note.
Factoids
The investment trust market is improving…Deutsche Numis has just released its H1 2025 report, suggesting that we should be in for another record year of M&A and capital returns. Highlights include:
M&A: On course for 2025 to be a record year for corporate activity through mergers and outright acquisitions, as well as buybacks, enhanced discount controls, tenders and numerous IC adopting wind-downs.
Buybacks on pace for a record year: Already ahead of every full year, apart from 2024. Buybacks in H1 25 up 25% to £4.6bn vs £3.7bn in H1 2024. A further £4.2bn returned through tenders/windups in H1 2025, bringing total return of capital to £8.8bn.
Discounts have narrowed: Universe ex 3i discount of 13.5% vs 16% at December 2024. Property and Infrastructure ICs have benefited from M&A, whilst boards of Equity ICs are introducing more active discount control mechanisms, with 10 introducing single-digit discount policies.
Performance: Europe and the UK amongst the top performing Equity ICs, whilst takeover activity has helped boost the performance of numerous Alternative Asset ICs, particularly in Battery Storage.
The kids get AI already. Exponential View reports that two-thirds of UK children aged 9-17 use AI chatbots regularly, and 35% of that group say their interactions feel like talking to a friend. “It’s not a game to me,” one 13-year-old boy told nonprofit Internet Matters, which conducted the survey of 1,000 people, “because sometimes they can feel like a real person and a friend.” [Futurism]
FTSE 100 smashes through the 9,000 mark for the first time. According to fund managers Martin Currie, “ with a 9% capital return this year and a robust 4% dividend yield, UK equities are delivering real value. Over the last five years to 30 June 2025, investors have enjoyed an impressive average total return of 11.3% per year—clear evidence that the UK remains a smart choice for long-term growth.”
ETF flows turn sharply negative. Fidelity reports that after a brief pause in US-focused ETF outflows in May, these once again faced negative outflows in June, particularly in the second half of the month. Overall, the ETF market slowed down significantly in June to USD 24 billion compared to the previous month, but achieved higher inflows than in April, the lowest net inflow this year. Notably, there is a decreasing momentum in equity ETFs. In contrast, bond ETFs were more sought after compared to the 3- and 12-month averages.
Empty Japanese homes. Dr Torsten Slok at Apollo reports that one consequence of a shrinking population in Japan is that there are more and more vacant homes, see chart below.
Note: 2030 forecast based on UN population growth estimates. Sources: Japanese Ministry of Health, Labor & Welfare, United Nations Department of Economic & Social Affairs (UNDESA), Macrobond, Apollo Chief Economist
Japan really is in a mess
“It’s important to recognise the dangers of a society and a world with interest rates. The government is not in a position to comment on interest rates, but the reality is we are facing a world with them. Our country’s fiscal situation is undoubtedly extremely poor, worse than Greece’s “ : The Japanese prime minister back in May.
Japan is in a challenging financial situation: massive government debt, huge fiscal deficits, FX volatility, tariff threats, an ageing population, and a volatile political environment. This precarious situation is highlighted in two notes from macroeconomists in the last two weeks.
Let’s start with Spyros Andreopoulos, a former ECB economist and now an economic commentator at Thin Ice Macroeconomics. In a note entitled Bank of Japan: Whack-a-Mole, The trilemma strikes back, ” Spyros maps out the choices that Japan might have to make.
“In a nutshell: the central bank of an economy with free capital mobility which has been suppressing government financing costs, keeps running into trouble in the markets as it attempts to raise interest rates.
What emerges is a connection between fiscal sustainability and financial stability in an economy with financial openness. I actually think that this tendency for things to break in markets, time and again forcing a (tactical?) retreat by the BoJ isn’t necessarily poor policy implementation – or even just bad luck. It’s symptomatic of a policy trilemma.
For the non-nerds: a trilemma is a situation where you can choose any two outcomes out of three, always at the expense of the respective third option. (Please bear with me, this should become clearer shortly.)
The three facets of the trilemma are as follows.
source: Thin Ice Macroeconomics
Japan can have fiscal sustainability (lower government financing costs) and financial openness (allowing its asset holders to enjoy higher returns abroad) – the base of the triangle. But it can come at the expense of financial stability as low interest rates give rise to the yen carry.
If Japan wants the government to keep borrowing cheaply to ensure fiscal sustainability, as well as maintain financial stability (suppress yen carry trades or bond market contagion) – the left side of the triangle – then it needs to restrict its financial openness. That would come at the expense of its asset holders, who can no longer enjoy high returns overseas.
Finally, Japan could maintain financial openness and financial stability (the right side of the triangle) by allowing its interest rates to rise towards global levels, weakening the incentive for the yen carry. But higher interest rates on government debt would risk fiscal sustainability.
Note that the recent bond yield episodes may suggest there’s no choice between financial stability and fiscal sustainability: if the BoJ relinquishes control over the yield curve, both may be at risk as rates rise violently; conversely, if it maintains control over the yield curve, there’s no bond market volatility, and fiscal sustainability is assured. In that case, the trilemma collapses to a dilemma between financial openness and fiscal sustainability.”
I suspect that in that situation, financial openness might be the weakest link in the end.
Perhaps before Japan encounters this challenging trilemma, its bond market will face a more significant challenge - the cost of Japanese debt, as reflected in elevated yields. According to economist Robin Brooks at the Brookings Institution, Japan bonds provide ‘cray low’ yields by comparison with their international peers. Yields on long-duration Japanese bonds have already been rising, but arguably not by nearly enough.
“The easiest way to see this is in the chart above, which shows Japan’s 30-year yield (white line) together with that for Germany (orange line). Even with the recent sharp rise, Japan’s yield is below Germany, which is nuts given Japan’s debt of 240 percent of GDP (versus Germany’s 65 percent). Many years of quantitative easing by the BoJ, as well as yield curve control, mean that Japan’s yields are still artificially low. And of course the BoJ remains a buyer of government debt in gross terms.
What does all this mean? Most advanced economies let fiscal policy run out of control after COVID, which has made a bad situation - where debt is concerned - far worse. As a result, the medium-term direction of longer-term interest rates is up, even if there’ll inevitably be lots of twists and turns along the way. Of all advanced economies, the UK in my opinion is closest to figuring this out. The Bank of England is allowing long-term yields to rise freely. That’s forcing the government to make painful adjustments and confront reality. Rising yields, when too much debt is pushing them up, are a healthy antidote to kick-the-can policies.”
Much as I am sympathetic to radical thinking about fixing the UK fiscal situation – my favoured medicine is a radical rethink on property taxes – one idea that keeps rearing its ugly head is a wealth tax. Just last week, Lord Kinnock, patron saint of the soft left in the Labour Party, floated a tax as a way out of the fiscal hole. Just like rent controls, wealth taxes are one of those bad ideas that just won’t die! The best argument against a wealth tax – it just isn’t practical – comes from an elegant put-down in the liberal Prospect magazine by tax guru Dan Neidle, who is usually a good source for most media outlets on tax dodging.
“Wealth taxes have a legacy of failure. In the last 25 years, 11 European countries repealed their wealth taxes because they raised trifling amounts, mainly hit the upper middle class and became hugely unpopular.
There are now only three countries in Europe that have such a tax: Norway, Spain and Switzerland. And the only one which raises significant sums is Switzerland (a unique case given that Switzerland has no tax on capital gains or inheritance).
But there are activists pushing a new kind of wealth tax they say is different. It only applies to the very rich, has no loopholes and promises to raise vast sums. Oxfam says a 5 per cent tax on the mega-wealthy could raise $1.5 trillion worldwide. These sums are a fantasy.
Spain recently tried a new wealth tax along these lines, aimed at the super-rich. It raised a derisory €630m. It was full of loopholes. Many wealthy Spanish left and fled to Portugal. Those are the two reasons why wealth taxes keep failing: loopholes and leaving.
All wealth taxes to date have had exemptions which in practice are used as loopholes by the very rich, leaving the upper middle class to carry the can. That reflects how legislation is made in practice, where the complications of the real world ensure that taxes are rarely implemented according to purist blueprints. That means that most taxes are flawed; but for the wealth tax, these flaws undermine the entire point of such a levy.
“Leaving” is the pretty obvious response that the super-rich would have to a tax they would (rightly or wrongly) view as confiscatory. Some people doubt the rich would leave. But we know that they would, because we can see what happens already. A large number of British entrepreneurs who are about to sell their businesses move to a tax haven like Monaco, and then sell—escaping UK capital gains tax at 20 per cent.
At first glance, a 2 per cent annual wealth tax, say, might not seem like enough to make someone move. But the real financial impact of paying 2 per cent of your wealth every year is much bigger than it seems. Over time, the cost of paying 2 per cent each year adds up—it’s economically equivalent to paying a one-off tax of about 30 per cent. This is because when you look at the long-term cost of those yearly payments, their combined value (using a reasonable “net present value” calculation) equates to about 30 per cent of wealth today.
Another way of looking at this: say that you receive a 7 per cent return from your wealth. A 2 per cent wealth tax means that two-sevenths of that return, or 29 per cent, is paid in wealth tax. That is on top of existing income tax at 39.35 per cent (the top rate of tax on dividends). So, in this example, a 2 per cent wealth tax creates a 68 per cent effective rate of tax on income.
For Oxfam’s 5 per cent wealth tax, the figures are much higher, equating to a one-off tax of 71 per cent, or an effective tax rate on income of 110 per cent. When people sell wealth taxes as “just a tiny tax” they are engaging in populism. The real impact is much higher, and therefore the real response would be much more dramatic. Anyone who thinks people don’t respond to a 110 per cent tax rate has never met a human being.
There are two recent proposals to solve these problems. The first, from the academics and practitioners on the Wealth Tax Commission, is a one-off retrospective wealth tax. Retrospective, so it can’t be escaped or avoided. One-off, to avoid an exodus of the wealthy afterwards. As the Commission’s report says: “If such a tax is unexpected and believed to be one-off—daunting requirements—it does not create economic distortions.” The requirements are indeed daunting; I fear they are impossible.
The other proposal, from the economist Gabriel Zucman, is a coordinated international wealth tax, introduced by every country simultaneously. But the countries with the largest number of billionaires—the US, China, India and Germany—show no sign of signing up to such a plan.Tax havens certainly won’t. And if billionaires can safely live and invest in countries without a wealth tax, then the idea fails.
A wealth tax is, therefore, a dead end. That certainly doesn’t mean we shouldn’t tax wealth. The UK already taxes wealth more than most of the rest of the OECD, but there is plenty we could do better. We could close the holes in inheritance tax, which make it essentially optional for the very wealthy. We could reform capital gains tax, preventing people from “converting” income (taxed at 39 per cent plus) into capital (taxed at 20 per cent).
We could reform land taxation, which at present consists of the rightfully unpopular stamp duty and business rates, and the inequitable council tax. A £100m penthouse in Mayfair pays less council tax than a £300,000 semi in Bolton, and that can’t be right.
Reforming existing taxes on wealth would be easier, fairer and more effective than creating a wealth tax. In fact, creating one will likely make us all poorer.”
Analysts at the Deutsche Bank Research Institute have just released their always amusing Global Cities survey. You can read this and many other reports at http://www.dbresearch.com/research-institute.
They reckon that “If 2012 marked “cheap US,” 2025 may represent “peak US”—at least in pricing terms.”
— Quality of Life: Luxembourg, Copenhagen, Amsterdam, Vienna and Helsinki are our top 5 cities. Zurich and Geneva have slipped out of the top five as cost of living is the most expensive in the world. Global financial hubs Tokyo (26th), Paris (44th), Hong Kong (48th), London and New York (tied 50th) score lower on liveability, hampered by expensive housing, long commutes, and high pollution levels. However this is a highly subjective measure. Frankfurt is climbing and is now 7th
— Salaries (net of taxes): Geneva, Zurich, San Francisco, Luxembourg and Boston top the ranks. London (17th), Paris (22nd) and Tokyo (38th) are lower when looking at averages.
— Salaries (net of taxes and rent): Geneva, Zurich, San Francisco and Luxembourg continue to be in the top 4 but Frankfurt jumps into the top 5 due to lower rents than many of its peers. Paris (26th), Hong Kong (35th), Tokyo (36th), London (37th) and New York (41st) struggle as the average rent is very high relative to the average net salary.
— Buying a city apartment (per sq. meter): Hong Kong prices have fallen c.- 20% in 5 years but still top the list, followed by Zurich, Singapore, Seoul and Geneva. London (6th) and New York (7th) are just outside the top 5. Beijing (9th) highlights the elevated property prices in China. Paris (12th), Tokyo (21st), Frankfurt (25th) are "cheaper". The biggest climber over the last 5 years is Dubai up 15 places to 37th.
— Renting a 3-bed city apartment: New York tops the list, followed by Singapore, Boston, London and San Francisco. Hong Kong (7th), Paris (16th), Frankfurt (31st) and Tokyo (34th) are further back.
— Utility bills: Even though rents are low, you can see the energy crisis in Germany first hand as Munich (top), Frankfurt and Berlin all make the top five. Warsaw, Vienna and Prague also make the top 10 showing that Central and Eastern European cities are counting the costs of the lack of cheap Russian gas. 18 out of the most expensive 20 cities are European.
— Public transport: London is 30% more expensive than 5 years ago and tops the list for a monthly pass. Sydney, New York, Auckland and Melbourne make up the top 5. Paris (12th), Tokyo (22nd), Frankfurt (tied 30th) and Hong Kong (33rd) are further down the list and Luxembourg is the very cheapest as most public transport is free
— iPhone: Turkey, Brazil, Egypt, Sweden and India are not good places to lose, and have to replace, your iPhone. Seoul is the cheapest as competition with Samsung makes it even cheaper than in US cities.
— Groceries: Geneva, San Francisco, Zurich, New York and Boston are the top 5 with all 5 of our US cities in the top 10. Paris (12th), London (25th), Tokyo (28th), and Frankfurt (35th) see relatively reasonable prices.
— Cheap Date Index: Geneva, Zurich, Copenhagen, Oslo, London and New York are expensive cities to be a romantic. Bangalore is the cheapest place in our survey to date.
— Wine: Singapore, Jakarta, Seoul, New York and Oslo are the most expensive. Interestingly some lovely cities make up the cheapest five, namely Rome, Johannesburg, Cape Town, Budapest and Lisbon. Lisbon and Cape Town are in the top 5 for best climates too which will help the wine go down.
— Cappuccino: A pick-me-up will be most costly in Zurich, Copenhagen, New York, San Francisco, and Geneva. Italian cities stand out as very cheap places to get both caffeine and wine!
— An imported beer: Dubai, New York, Oslo, Abu Dhabi and LA are expensive places to drink beer in a restaurant.
— Cigarettes: Most expensive in Melbourne, Sydney, Wellington, Auckland and London where very high duties aim to dissuade consumption and raise revenues.
— A summer dress: Buenos Aires, Geneva, Oslo, Riyadh and Dubai are the most expensive.
— Jeans: Don't double denim in Zurich, Geneva, Copenhagen, London and Edinburgh as they are the most expensive.
— McDonalds: Don't double up your burgers in Zurich, Geneva, Tel Aviv, Copenhagen and Amsterdam.
— Restaurants: Zurich, Geneva, New York, San Francisco and Boston are the most expensive.
— Cinema: Zurich, Geneva, London, Copenhagen and New York bring Hollywood level prices.
— Gym: New York, Singapore, Doha, Riyadh and San Francisco will cost you plenty of dollars to shed a few pounds.
— Petrol/Gas: Driving is expensive in Hong Kong, Zurich, Amsterdam, Geneva and Copenhagen. — Buying a car: Singapore and Copenhagen actively discourage it and are the most expensive followed by Tel Aviv, Istanbul and Abu Dhabi.
— Internet data: Most expensive in the Middle East and the US.
The most recent GDP numbers for the UK were grim reading, again. UK GDP missed consensus estimates, with a 0.1%M correction. The first quarter clearly saw the UK economy under pressure from tariffs and tax shocks, which should hopefully unwind in the second quarter.
Overall, though, according to economists at Morgan Stanley, the UK economy “is flatlining, and slack is building. The BoE will, we think, accelerate cuts on more evidence of that slack translating to disinflation”.
Manufacturing: The monthly correction in activity was driven by manufacturing, which declined by 1%M - moderately less than we had expected (-1.3%M). May has seen an unwind of strong pharma activity into the US tariff deadline, and if anything, the decline in auto production as captured by the ONS seems a bit too modest (-3.8%M) vs. the data from SMMT that pointed to the worst May for the sector since 1949. This number, we think, could yet be revised downwards. We do note that the March GDP pick-up was indeed revised up, from +0.2%M to 0.4%M. Finally, looking at the impacts of global trade policy volatility, we see some building evidence of a sustained and robust rise in non-EU imports of finished manufactures (electrical machinery, particularly) and clothing over 2Q. Normally, this could be interpreted as a sign of strong domestic demand. Today, however, it looks like nascent effects of trade diversion, which should help keep a lid on core goods inflation.
Services: Consumer-facing sectors fared a bit worse than we anticipated (-1.2%M decline), with a decent correction in the arts & entertainment and retail sectors. Accommodation provided a bit of a boost, as we expected. Overall, for all the favourable weather, the UK consumer still looks pretty reserved. The services sector, however, did grow in May, boosted by a surging ICT sector, up by 6.8%Y. The driver might be, we suspect, business capex investment in AI-related services - a phenomena which is hard to square with growing bearishness by the BoE on the UK's productivity growth.
What next? As growth surged in 1Q, the BoE cautioned that the underlying pace of growth does look flat. It is becoming fairly clear that the BoE's (and our own) assessment was accurate - the economy was boosted by front-loading in 1Q, and the unwind of that boost is a drag on 2Q activity. The UK, hence, is not much different to the euro area in 1H25. We are still tracking a mildly negative 2Q growth print, although we do see high-frequency signs of auto production (and exports) picking up in June. Hence, we assess the risk to our current -0.1%Q tracking as skewed towards a flat quarterly print instead. Since the survey data has been a decent guide of activity thus far this year, we do note its encouraging uptick in June, with even the housing market perking up a bit at the end of 2Q, as per the RICS survey. Activity, as of now, looks set to come in broadly flat to mildly positive in 2H, although we caution about downside risks posed by the labour market. Overall, such a soft pace of growth implies, we think, a healthy build up of slack, that will continue to weigh on pay and underlying inflation pressures. The BoE will, we think, accelerate cuts on more evidence of that slack translating to disinflation. We see a cut in August, and at consecutive meetings this year thereafter.
For the tech speculator
WisdomTree, a global ETF issuer, has expanded its range of thematic short and leveraged (S&L) ETPs with the launch of 3x short and leveraged Magnificent 7 and semiconductor equity exposures, all listed on the LSE and with a TER of 0.75%. These really are only for speculators and day traders:
WisdomTree PHLX Semiconductor 3x Daily Short (SC3S)
The new S&L ETPs provide 3x daily leveraged and 3x short/inverse exposure to the WisdomTree US Bluechip Select Index (NTR) and PHLX Semiconductor Sector Net Total Return Index.
Vanguard on why we hold too much cash and not enough investments
The massive asset management firm Vanguard has just released a comprehensive report, "Core Components of a Successful Retail Investment System," which argues that significant pools of cash, at least US$2.1 trillion (£1.7 trillion), are sitting in excess savings across leading OECD countries. The research suggests that many individuals could improve their long-term financial outcomes by investing in the capital markets, provided consumer-friendly retail investment systems support them.
The research identifies a broad global trend: despite an estimated US$51.7 trillion in household savings across all OECD countries, too few individuals are investing their money in the financial markets. It further estimates that if households in the most populous OECD countries reallocated just 10% of their excess cash savings into investments, capital markets could grow by US$2.1 trillion.
This underutilisation of savings is particularly striking in today’s economic environment - ageing populations, deteriorating public finances and the shift to defined-contribution retirement schemes make it increasingly important for individuals to take responsibility for their long-term financial health.
The big Chinese tech giants (ByteDance, Tencent and Alibaba) are intensifying their competition in the all-important local AI market. This is from Caixin Global via Adam Tooze.
“The two juggernauts aren’t just racing each other—they’re positioning themselves differently. Alibaba is betting on cloud-based “Model-as-a-Service” offerings, while Tencent is focused on embedding AI into its massive consumer platforms such as WeChat. Their battlegrounds now extend into verticals like education: in May, both launched rival AI agents aimed at helping students with China’s grueling college entrance exams. At the same time, the two giants have become aggressive investors. From 2023 onward, they’ve poured capital into nearly every major domestic model startup—MiniMax, Zhipu AI, Moonshot, Baichuan and more. Tencent even paused its own model development at times to back DeepSeek. Alibaba slashed non-AI investments to go all-in. Meanwhile, ByteDance—creator of TikTok and Douyin—has been steadily building its AI empire too, consolidating research under the new Seed division.
With Wu Yonghui, former vice president of Google’s DeepMind, at the helm, ByteDance is aiming to repeat its algorithmic dominance from the short-video era—only this time with generative AI. The race isn’t just about who builds the best models. It’s about who defines the next era of computing in China—and beyond. As one Alibaba executive put it: “AI’s impact on the world has barely begun. It’s far too early to talk about winning. This is just the beginning.” If Tencent is sprinting to dominate consumer-facing AI tools, Alibaba is digging in for a long war—one fought on the deeper, more expensive battlefield of infrastructure. It’s a strategy as technical as it is philosophical: open-source to shape the ecosystem, and model-as-a-service (MaaS) to monetize it. Alibaba was one of the first major Chinese tech firms to fully embrace open-source AI development. “Their plan had three legs,” said a partner at a venture firm focused on AI applications. “Build their own base models, buy or build an AI chatbot company, and invest aggressively across the stack—from infrastructure to end-user applications.” As it turns out, they only needed two. Alibaba’s foundational model family, Qwen, proved so robust that plans to acquire another base model firm were quietly shelved.
