SAC-CIC?
OK, SAC-Temasek seems a bit more likely. But SAC (A big hedge fund) does seem to be marketing itself to a range of Asian state investors.
“SAC has been marketing possible stakes in its management company to foreign investors including Asian state funds such as Temasek of Singapore.”
That is why the FT’s headline (the sale to private investors bit) seemed off. State funds aren’t quite private investors, at least not in the classic sense.
A lot of big official investors are buying in to their money managers – or, in China’s case, perhaps buying into their future money managers. Think:
- CIC-Blackstone
- ADIA-Apollo
- CDB-Barclays
The FT again:
Many of the stakes are being bought by cash-rich investors in Asia and the Middle East.
Too bad all the GCC countries and China seem to be devoting more energy to finding new ways to manage their money rather than finding new ways to manage their exchange rates …
But unless something changes in the US debt markets, a lot of market actors who depend on leverage and liquidity may not prove to be all that great an investment.
My own personal theory is that the Wall Street-GCC-CIC-Singapore financial alliance really got started with China’s sale of minority stakes in its big commercial banks. Big American and European banks, Singapore's Temasek and the Gulf investment funds (not just ADIA) all were all among the early investors in China's state commercial banks. And they all did very well out of the process.
The same names that did the ICBC, CCB and BoC deals keep popping up. Then again, the same names also may keep popping up simply because they really do have a lot of money.
And unlike some folks on the Street right now, the big government funds are also very liquid.
“…The opportunity might even pique the interest of a wealth management company wanting the extra benefit of access to SAC’s funds for its high net worth clients…” http://www.ft.com/cms/s/8b153844-3a39-11dc-9d73-0000779fd2ac.html
“…the full takeover of private sector assets by foreign governments is moving inexorably to the heart of the agenda…” http://www.ft.com/cms/s/29de04e6-3adb-11dc-8f9e-0000779fd2ac.html
SAC-Temasek are state-owned funds that invest in global equities and bonds. So too are the California state employees pension fund, the New York City employees pension fund, the US Federal government employees pension fund, etc. The California state pension fund takes an especially active role in pressuring corporations for various causes. Under its management, the state-owned, US Federal government employees pension fund has over $300 billion in assets, and also invests in foreign equities, domestic equities, corporate bonds, etc. Why the concern over the Chinese state-ownership of foreign equities when the US Federal and state government agencies employ a similar financial strategy.
DC’s right on this one. In fact, there has been increasing attention paid to state pension funds being reshuffled to reflect policy goals, especially in so called “terror-free” funds. Shell Oil is having to deal with pension fund pressure related to its activities in Iran, for one.
http://business.timesonline.co.uk/tol/business/industry_sectors/natural_resources/article2141144.ece
The WSJ link below (subscription required) goes into this in more detail, particularly the conflict of interest involved.
http://online.wsj.com/public/article/SB118178438003134761.html
Dave,
I am always amused with your attempts to portray China as:
a. Put upon by Western powers who should mind their own business
and
b. Really nothing more than a socialistic society embracing capitalism.
As far as the latter is concerned, there is a big difference between state-owned pension funds and companies owned by the national government. The leverage of the former is miniscule compared to the leverage of the latter–especially in a totalitarian, one-party state that has a firm and absolute grip on not only the legislative process but also on every dimension of the media.
Imagine, if you will, the U.S. or Britain laying out a precise blueprint for the 80 years…and that blueprint being fairly specific for the next twenty, including what the average wage will be 20 years hence. China is a command economy with an intelligent and well-conceived agenda for becoming a “frontier” nation. I personally do not think the blueprint is viable, especially considering global warming and resource depletion. Nor do I think its economic plan viable if it refuses to increase GDP per capita. The problem with totalitarian systems is that when they make mistakes…they make whoppers. And China, I think, is making a whopper.
Anyone who bothers to read China’s blueprint, which includes a careful ranking of its competitors and its place within the “competition” has to be amazed and a bit awe-struck. China carefully measures itself in a wide variety of areas, gauging how it places in each area against a wide range of other countries. In this respect it has far less “hubris” than the U.S. which is always beating its drum that it is the “best” in everything.
It was not too long ago that we were told that the U.S. medical system was the best in the world….now it is collapsing. Hubris. National pride at its blindest. And that pride and hubris extends to many areas. The U.S. would do well to start being a bit more reality-based, a bit more humble.
And that pride has blinded the U.S. to precisely what is happening…all because many economists, together with corporate America and politicians of both parties, are convinced that globalization as it is proceeding is next to motherhood and the U.S. alone is the shining light of the world.
How globalization is proceeding is a disaster in slow motion. Globalization is important, but the implementation is everything. And that implementation is deeply flawed.
I am not the greatest fan of how the U.S. works, but I am not naive as to how the Chinese system works. I certainly have criticized both. (I inserted the above criticism of the U.S. just for your benefit.) You, on the other hand, seem content to be just a cheer-section for China, employing rather lame comparisons in order to obliterate real and deep differences.
You are too bright and well-informed to be just a cheerleader. Take a good swipe at China and see what you come up with. It’s a big and an easy target.
Try this criticism on for size: What China does and how China behaves affects everyone…including other developing nations, which are now complaining, by the way. Because its actions affect others, those others have every right to complain. And that includes the U.S.
“Why the concern over the Chinese state-ownership of foreign equities when the US Federal and state government agencies employ a similar financial strategy. ”
Because US people can vote to change the policies of the US agencies if they start meddling too much in US domestic private companies through their investments.
In practical reality, a very large proportion of the state pension and university endowments are invested in market-weighted index funds. There is some brouhaha about some issue of the day, like tobacco-free, and Sudan-free, yadda yadda, so they are effectively index-minus-a-little-bit funds. The US Federal employment pension (403b), is entirely in the most vanilla index funds. (www.tsp.gov) The public pension funds publish their investment strategies and holdings quite regularly and are generally pretty open. There is some investment in private equity and some other opaque assets, but entirely for rate of return.
This is totally unlike what the international sovereign wealth funds appear to be. Most appear to be very secretive, sometimes taking large stakes. There is significant theoretical worry that the funds could use influence for reasons unrelated to rate of return of the portfolio but perhaps the reverse—use their influence to handicap firms which are competitors to their own domestic (and often not externally investable) industries. Or alternatively, non-rate-of-return motivations like taking a company private and extracting its proprietary technology for use in their own domestic industries, “nationalization by capital markets”. Obviously owners of a private company would usually have no motivation to do that—help their competitors and hurt their own business, but if viewed from a national point of view it makes sense. The growth in their local business would more than offset the loss from the wealth fund in the foreign business.
A US public pension fund has no motivation to try anything like that and sufficient openness that they’d be immediately caught and stopped—e.g. Calpers stealing technology from a Texas company for the benefit of Silicon Valley.
A sovereign wealth fund, if they view their mission sufficiently broadly, might consider those kind of sharp strategies as imperatives.
If the current and ginormous currency reserves are being held for entirely passive non-rate-of-return reasons, then a sovereign wealth fund which pursues rate-of-return strategies for some of the portfolio and national strategic activities with the rest appears to be a non-brainer step up.
So, to me there appear to be the possibility of substantially distinct motives and activities from large sovereign wealth funds compared to domestic public pension funds.
There are capabilities and motives for these investment funds to harm the US.
It doesn’t mean that they actually have done, currently do or will do this. But the barriers are not high, and there is reason to worry if the funds get sufficiently powerful.
Written by Matthew Kennel
The real issue isn’t public vs private, but scale and unity-of-control. The herds of public pension funds around the world might be formally state-affiliated, but they are independently run fiduciaries whose investments are made on behalf of distinct communities of beneficiaries, and who by charter seek to maximize return and minimize risk in accordance with the particular circumstances and expectations of beneficiaries. It is conceivable that states could try to impose unity-of-control for strategic reasons on the welter of state-affiliated pension funds, but that would require very large changes, both in practice and in law. Aniym makes a good point that creeping norms could impose a certain degree of unity. But for the most part, pension funds and other institutions are independent and diverse, are relatively transparent, and are subject to a great deal of constraint in terms of achieving very concrete beneficiary goals. The main agency issues have to do with firm-manager goals vs beneficiary goals, rather that state-strategic pressure.
If there were private entities amassing hundreds of billions of dollars per-annum in no-strings-attached equity funding and investing those funds towards obscure strategic objectives of fund managers, with little transparency and no requirement or expectation of any financial return to shareholders, that would be equally problematic. Sovereign wealth funds are actors large enough to move macro markets, they behave very differently the fictionalized agents of financial theory, and their constraints and objectives are mysterious. We have no reason to believe that markets populated by such actors are likely produce “good” or “efficient” outcomes. People who suspect their own objectives might be very different than the objectives of the managers of such funds would have especial reason to be concerned.
Stormy:
I must disagree with your take on Chinese economic blue print. Why believe something that stretches 80 or 20 years out when most Chinese ignore the directives 1 month out? Think China will be same politcally 20 years from now?
Mathew Kennel:
If US public pension funds behave so well, then how do you explain the mess in San Diego County Public Pension funds, where billions were lost gambling on real estate? How do you explain the incredible growth in hedge funds which are secretive, non-regulated and sufficiently powerful?
I agree with Twofish here. If the SWF go for risk adjusted maximum returns, we should treat them just as any other large, sufficiently powerful, unregulated entity.
Isn’t is funny how little complaining there was when the vast majority of Chinese PBoC capital was parked in low interest US Treasury Bonds. Now that the Chinese government decides to diversify low yielding assets into global equity investments, there is suddenly an uproar of criticism in the mainstream US newsmedia. What are Americans complaining about? The Chinese have recently invested in a British Banking institution, not an American money center bank. They have specifically assured Treasury Secretary Hank Paulson that U.S. acquisitions are completely off the table due to US national security concerns. That the Chinese hope to reduce holding of US Treasury bonds and other US bond investments, redeploy the capital into higher yielding equity investments in other countries, should actually please American concern over US National security.
The sheer scale of SWFs (not to mention Central Banks) and their potential impact upon market integrity in general and a nation’s socio-economy in particular are sufficient reason for a binding Treaty that spells out what one [unilaterally] shouldn’t and cannot do. CDC, ABP, Ontario Teachers CalPers, are model citizens to any such Treaty-order. Temasek is perhaps still earning its stripes, but under any reasonable systemic boundary, neither BoJ, PBoC or SAFE would be able to subvert the prevailing international monetary order as they have done without multi-lateral agreement.
hmmm — if US aquisitions are off the table (tho not minority stakes a la Blackstone I assume) and if China needs to put around 70% of its reserves into $ to keep the $ from falling further, China either will end up with a portfolio of European and EM equity and US debt, or it will need to start to buy US equities. I think US concerns stem from the scale of Chinese $ denominated asset accumulation implied by the continued $ peg. I would be a lot less worried if china were no longer adding to its assets and was just shifting some funds from treasuries to an equity index fund …
“America’s Committee on Foreign Investment has made it clear that it will consider the openness of other countries’ markets when their governments are trying to buy American companies. On July 25th Alistair Darling, Britain’s chancellor of the exchequer, said that Britain would resist any calls for protectionism arising from worries about sovereign-wealth funds, as long as the governments that backed them kept their markets open. If they want things to stay that way, the funds should open up too.” http://www.economist.com/finance/displaystory.cfm?story_id=9556414
DC — Lots of us complain about central bank / SWF investment even in US treasuries. Equity investments open up a new and colorful set of hazards, but actors large enough to materially affect markets over a substantial period of time, who lack perfect information and whose motivations transcend efficient resource allocation, do damage to the purpose and function of capital markets, whatever they invest in.
capitalism and markets are a game which play best with multiple independent players. an entity which is too big tends towards becoming a monopoly and spoils the game. you need a definition of how big is too big. i suggest any player who cannot enter a market, or sell their entire holding, without causing a financial earthquake – is too big.
you know what i mean. can anyone put it more precisely ?
china’s too big.
Although this may be a ‘Canadian’ example, and not a deal which involves China or an SWF, although not sure how Deripaska intends to finance it: “…one of the issues could rest on concerns about whether capital flows will be directed to Russia and Eastern Europe… or to North America… Another sticking point… is the “fact that control, or ownership, of a big chunk of the votes will be in the hands of a Russian oligarch who technically is not allowed into the U.S.” Deripaska, described by Forbes magazine as Russia’s second richest man, cannot travel to the United States since being stripped of his U.S. visa for suspected criminal links…” http://www.globeinvestor.com/servlet/story/ROC.20070726.2007-07-26T184120Z_01_N26291958_RTRIDST_0_BUSINESS-MAGNA-COL/GIStory/
Of course, gilles, that’s the core of the problem!
US was the bank playing monopoly, but some other player got too big.
China became a too big player following the bank’s guidelines…
How do you stop it?
Let’s see.
PS: Hi, Brad, have you read Menzie Chiin’s “Will Dollar Depreciation Prevent A Recession?”. BTW, it mentions you.
Issues differing with each asset. And as there are many influential – influence dependent on more than just size – highly specialized entities, perhaps also interesting to consider potential concerns which may arise if SWFs already have, or possess the future potential to establish controlling, or significantly influential, stakes in law firms through share ownership or client relationships: “…Parliament is expected to enact a law this year enabling law firms to sell shares on the stock market. Australia has already taken the step… “The jury is out on what will happen,” to the legal industry, said Jeremy Black, who follows law firms at Deloitte & Touche in London. “There is a wall of money in the investment community…” http://www.nytimes.com/2007/07/25/business/25lawyers.html?_r=1&ref=business&oref=slogin
How about structuring SWFs in some way that ‘foreign’ investors may be allowed to take large stakes in SWFs in the way that SWF’s may be planning to take stakes in ‘foreign’ firms – assuming this is not currently possible, if even desirable or feasible, or implicit through currency pegs or other mechanisms.
No reason to believe that nationalist/totalitarian agendas must necessarily penetrate minority (or governance constrained) positions in US equities. Who cares about SWF agendas, provided they live by the rules of US corporate governance and control in the case of US public equities? And I don’t think Blackstone is going to roll over for totalitarianism. Constraints on public investors (e.g. Calpers) are intended to bind them in their influence on domestic equities and domestic conflicts of interest – not foreign. We don’t need to protect China against itself on this issue. In that context, even Calpers-like activism by China would be acceptable, and potentially productive, provided its totalitarian sourced input is considered within the larger framework of market fundamentalism in the case of US public equities. And US managements might benefit from some ant-hubris input. I don’t think scale is the immediate concern. The multitude is bent out of shape already on $ 3 billion in Blackstone. David Chang has an interesting point on the different reaction to equities rather than Treasuries, but even the treasury reaction has been hysterical with respect to effect on the general level of rates. The real problem is that the US has hoover’d cheap goods from China for years, but now wants to change the rules when natural investment consequences are unfolding. Makes a lot of sense to whine about exchange rates and market yields while accepting import avalanches with an embrace of market fundamentalism. That’s as short sighted and naïve as China’s equity play is long-sighted and strategic.
US Treasury is the Head of the Currency Manipulation Snake
http://www.atimes.com/atimes/China_Business/IB15Cb03.html
As the dollar is the key reserve currency in world trade and finance, the US, through its interest rate policy, is the de facto head of global exchange rate manipulation snake and the Fed chairman the chief wizard of exchange rate manipulation.
For decades, beginning with a collapse of budgetary and monetary discipline during the Vietnam War, the US had been manipulating the exchange rate of the dollar downwards, a fact obscured in the last decade by the emergence of dollar hegemony, a regime introduced by Clinton Administration Treasury Secretary Robert Rubin to finance the US trade deficit with its capital account surplus to deliver borrowed prosperity to the US through a global debt bubble fed by the US Federal Reserve’s dollar printing frenzy.
Thus it is irony bordering on disingenuousness when Federal Reserve Chairman Ben Bernanke, in China as part of the US-China Strategic Economic Dialogue delegation led by Secretary Paulson, voiced concern for the allegedly undesirable distortions that result from an “effective subsidy that an undervalued currency provides for Chinese firms that focus on exporting.” For decades, the real market distortion has come from the Fed’s interest rate policy, liquidity bias and inflation targeting. By law, the Fed is obliged to support the Treasury’s strong dollar policy in defiance of market forces as a matter of national security. And a strong dollar policy is a professed example of currency manipulation.
DC — the Atimes argument is ridiculous. last I checked, eurozone liquidity growth is faster than US liquidity growth (so is China’s). Us rates are also higher than eurozone rates. and certainly higher than Chinese rates.
bottom line — if China doesn’t like US monetary policy, why does it insist on importing an even looser policy (countries that peg facing pressure for appreciation generally can have looser but not tighter monetary policy than their anchor … )
anonymous — China has a long-term strategic policy of loosing massive amounts of money on its government savings (and holding domestic real rates artifically low, hurting a lot of small savers) … China so far has experienced the benefits of its massive export subsidy, but the off-balance sheet losses are growing, and eventually those losses will be realized. And if its current policy is so strategic, why didn’t it adopt it earlier — in the 90s, it pegged to an appreciating $, presumably at some cost to itself given how much it has gained from subsequent RMB depreciation?
gillies. you hit the nail on its head.
steve waldman, matthew kennel, cassandra — interesting comments. thanks for helping me think through the difference between Calpers and a SWF.
I’d say it was strategic to adopt an exchange rate policy that avoided the ex-China Asian meltdown in the 90’s.
The essence of strategy is not socio-economic dependent. It isn’t a function of moral judgment. That’s a different issue.
There’s been lots of debate about the eventual exchange rate cost of the export subsidy. Don’t look to the US to throw in the towel on the dollar. Their weapon is the Fed funds rate – lowering it less than expected or more slowly than expected will limit dollar declines to much less than the prevailing wisdom of impending catastrophe. (Look to the collapse of the gold bulls for the eventual exhaust fumes on that story).
But that funds strategy will also cost the US a recession. Ironically, China’s “off-balance sheet cost” may be transformed and transferred to the US.
Finally, remember the Fed’s original role in this. They lowered funds to 1 per cent. That’s the ultimate origin of most of the outsized foreign reserve accumulation.
[q]If there were private entities amassing hundreds of billions of dollars per-annum in no-strings-attached equity funding and investing those funds towards obscure strategic objectives of fund managers, with little transparency and no requirement or expectation of any financial return to shareholders, that would be equally problematic.[/q]
And China has some very strong reasons to make sure that its state-owned funds are managed professionally and transparently. They main reason is that having opaque accountability for investment makes it very difficult for the State Council to know what is going on with the funds. The other reason is that non-professional management leads to corruption and losses which makes it harder for the government to maintain legitimacy.
I should point out is that a lot of the nervousness is what sovereign wealth funds could theoretically do, rather than what they are doing. In the case of China, I think a lot of this is misguided because the Chinese government knows what a mess unaccountable and opaque funds can cause (ask the former Mayor of Shanghai). That is why they are looking at Blackstone and foreign banks to manage Chinese funds.
Brad:
I have to respectfully disagree. I think Anonymous on 2007-07-26 15:24:53 hit it right on.
Regarding the arguments that China is too big, how big is the US capital market? The European one? I think China’s meager $1.5T hardly qaulfies as monopolistic.
Regarding Calpers as “model citizen”, what is it that qualifies Calpers as a model citizen? Is it because it has large group of shareholders and offered reasonable returns? Is it because it followed US rules? Is it because it has remained passive in most of its holdings? Is it because it’s US based?
Twofish:
Good points. I agree.
[q]The leverage of the former is miniscule compared to the leverage of the latter–especially in a totalitarian, one-party state that has a firm and absolute grip on not only the legislative process but also on every dimension of the media.[/q]
There is much less command and control in China that the stereotype suggests, particular with respect to economic issues. China has a lot of different interest groups and different people have different ideas as to the way that the country and the economy should be run. The Party has tended to loosen its grip in areas that don’t threaten its power so that it can maintain a tighter grip on things that it can. In economic issues, there is a lot of debate and discussion of policy because the Party does not want to do something stupid that will cause it to end up like the Soviet Union.
Totalitarian command economies just don’t work. Authoritarian market economies can work. The reason I make the Calipers comparison is that there is an effort by the Chinese central government to create funds that are look and act like Calipers because that system is known to work. So I strongly suspect that the SFIC and Huijin are going to end up looking like American state pension funds, because that is the model the Chinese government is using to figure out what they should look like.
twofish — Calpers follows US rules, is accountable to its beneficiaries (though like all money managers, imperfect) and works with the established US market ground rules. It also is much smaller than the CIC likely will be in a few years.
LC — I personally find blackstone rather opaque compared to say Norway’s government fund. And I prefer Norway’s gov. fund model to ADIA-apollo. If i thought the CIC was going to be more like the gov. fund I would be less concerned. but its model seems to be more like QIA or temasek (i’ll blog on this)
LC — It is $1.5 trillion growing by $0.5 trillion a year for China, and $5.5 trillion (in reserves) growing by $1.2 trillion a year + $2 trillion in sovereign wealth funds growing by around $150b from oil related flows and more from capital gains and shifts in reserves. in aggregate, central banks are now very big relative to parts of the treasury market (they reportedly hold over 75% of some off the run issues in the 5-10 year range), and increasingly big relative to parts of the agency market.
China will be adding $400b to its US assets every year on current trends (actually on current trends it will be adding more than $400b every year). that isn’t huge v the total equity market cap. but it does imply that china may be financing a bit under 1/6 of all investment in the US (investment is around $2.6 trillion v $400b). that suggests it could in aggregate exercise a significant impact on the allocation of capital inside the US (it already has — chinese demand for agencies helped fuel the housing boom, and its demand for safe assets helped generate low rates and a lot of liquidity that pushed others into risk assets)
Anonymous — “Finally, remember the Fed’s original role in this. They lowered funds to 1 per cent. That’s the ultimate origin of most of the outsized foreign reserve accumulation.”
not true. When the fed raised rates, Japan stopped intervening, but most emerging markets continued to intervene. if the origin of accumulation was 1% rates, the end of 1% rates should have stopped the accumulation. It didn’t. China’s reserves are growing far faster with US rates at 5.25% (and relatively subdued us growth) than with US rates at 1%. you are avoiding the hard questions in my view by pinning all the blame on the fed.
US policy has changed since 03-04. fiscal policy is tighter. rates are higher. and EM reserve growth has accelerated, not decelerated. that is the deep puzzle.
Bravo! Dave Chiang, Anonymous, Twofish, and LC – I could not have thought out or presented in such logical detailed manner — you guys can count me in (I will return to the sideline …)
Keep It Up and Steadfast!
It is funny how pension funds are held up as model citizens. Here in San Diego the city pension board (okay there is some difference from board to fund manager) colluded with city managers to take the taxpayers for a ride. The board members were not shy from personally benefiting either. The county board was in turn fleeced by hedge funds (remember Amaranth, anyone?) Ontario Teachers are known to take majority positions in companies or buy out companies altogether. Maybe you think the buyout is for the benefit of minority shareholders? The pension system for public employees through portfolio investment is fraught with problems. If they beat the market, whose pockets do you think the “beat” come from? If they do not, but their actuary projection depends on it, taxpayers still have to foot the bill.
Brad:
Thanks for your response. I look forward to your next blog on government fund models, but in the mean time, I find the argument regarding distortion of capital resource unpersuasive. No doubt China’s investment has had a significant impact on US activity, but that’s to be expected from a growing economic relationship, right? Isn’t the solution to this problem widen the playing field, e.g. invest in Chinese markets as they open up, taking up stakes in their banks and consider Chinese interests when we make decisions? To attempt to narrow the playing field by somehow setting rules on what their capital can do versus ours seem somewhat counterproductive.
Also, I’d like to understand why you find the EM reserve growth so puzzling. Isn’t it because they peg to the dollar and have realtively loose monetary policies?
A more flushed out version for those not familiar with the problems of government pension funds:
When pension funds brag about the their alternative investments in things like commodities, where does one assume the extra profit come from? The average consumers/investors of course. (Not to mention the enrichment of PE and hedge fund managers.) When they do produce good returns they in turn allow the pension boards/unions to push for more pension benefits. No cost to the tax payers, they would say. Their investment will make up for it. Well the reality is not Lake Wobegon. They can’t all beat market all the time. When they do run into trouble, they can always count on the tax payers to bail them out.
why do i find EM reserve growth puzzling? B/c I never expected poor countries to finance rich countries on terms that imply large losses for the poor countries.
and remember that China cannot open up its markets to inward portfolio investment so long as it keeps the rmb artificially cheap. it has no intention (nor should it) of allowing us and other investors to buy real assets in china cheaply, and in the process, force china’s taxpayers (through its central bank) to buy more us asset … the current system effectively precludes a sound reciprical economic relationship. that is what bothers me. and rather than putting it on a sounder basis, china is mucking around trying to juice up its returns by taking more risk and trying to reduce its exports of labor intensive goods when it needs to find more jobs, not less to address the fall in labor income in china.
in my view, china’s model isn’t working. but its true costs are hidden — and i am very worried about how china reacts when it discovers the magnitude of its losses on its us lending (losses that could get bigger if more risk produces a San Deigo country outcome, not somewhat higher returns).
HZ:
Good points on government pension funds.
Brad:
Good arguments, but isn’t part of the problem the Chinese haven’t been able to buy real US assets? Each time they try, it’s a “national security” concern, or a “market distortion” concern. I for one believe the Chinese will behave differently if CNOOC had been able to buy UNOCAL without all the political fuss. I absoutely agree with you about potential Chinese losses, but I think part of the defense will be (rightly) some finger pointing at US for keeping real US assets out of view. I think Paulson and company would have an easier time with RMB appreciation and opening up of Chinese markets if the Chinese had real US assets.
My point is that 1 per cent fed funds had everything to do with the explosion of consumer and mortgage credit and mortgage equity withdrawal – and that had everything to do with aggregate demand, including the trade component of the current account deficit (aided and abetted by the peg, of course) – and that had everything to do with external imbalances and foreign reserve accumulation and concentration. It was the logical beginning of outsized deficits – not the end. Interest rates had a very powerful effect on aggregate demand as a single force.
Ensuing events in the face of cumulative Fed tightening are a function of pronounced economic lags in consumer behavior from that origin. Low interest rates propelled related asset market activity (housing and equities) long after the very lowest rate was in effect. Monetary policy works with a lag. Look how long it’s taken for the housing crisis to take hold and for credit spreads to widen. The widening of credit spreads in particular is an enormously lagged effect just now catching up to the cumulative rise in the funds rate. (I would characterize credit markets that way, rather than the way that Gross does as a further equivalent funds hike ex credit spreads.)
The failure of the current account deficit to begin to decline is a function of these demands and these lags, as well as well as the peg in China’s case.
I don’t blame the fed for everything, but I do want to put the funds rate into context.
On the fed funds rate and China’s peg – the US will fight rigidity with rigidity. The US will keep the funds rate relatively firm in response to China’s resolve not to be pushed too quickly on the peg. It will win the battle against the risk of domestic inflation at all costs, and in doing so will start the slow process of unwinding risk on external imbalances (via recession), just as China works through the slow process of doing the same by crawling the peg.
China has built massive risk into its position via the export subsidy (the XR peg).
The US built massive risk into its position via the import subsidy (the 1 per cent funds rate (and its lagged effects)).
Both countries are now screwed in terms of risk. The question is how that risk unwinds.
It will be shared to some degree.
The only real alternative the US has to the funds rate is trade protectionism – which the Democrats won’t touch with any perseverance for another 18 months at least.
The position of US market fundamentalists is asymmetric (if not bipolar) with respect to international balances. The neo-con talking TV heads applaud open markets (for imports), but absolutely insist on ignoring any suggestion of risk in the US external position (this was also Milton Friedman’s position). The more studied positions tend to decry the risk of the external position, attach most of the blame to the XR/export/surplus side of the equation, while being more or less agnostic on the moral position of the import side.
The first group seems naïve with respect to external imbalance risk, as well as the potential for global conversion to market fundamentalism (interesting parallel with Iraq democracy naiveté).
The second group seems well aware of the imbalance risks, but somewhat inflexible to the notion that we live in a world of asymmetric market behavior. Wishing that China wouldn’t behave like China does behave is a bit insane after years of US current account effects. Is it rational to expect a change in this mode of behavior in order to bring about an outcome favorable to the US?
The US must now take the situation into its own hands. It must use some combination of the tools at its disposal – which mostly amounts to the Fed funds rate, because the US is loathe to resort to protectionism when it has been the global cheerleader for market fundamentalism.
But time is running out. The relatively sudden and desperate emergence of the relatively new issue of US asset protectionism is an indicator of this.
As I said, I don’t blame the Fed for everything at all. And I do question the moral rectitude of China’s strategy. It’s just that my natural response to arguments that appear inherently asymmetric is to offer the other side asymmetrically.
Anonymous:
I am still poring over your arguments, but 1 question:
What is your definition of market fundamentalism?
“Is it rational to expect a change in this mode of behavior in order to bring about an outcome favorable to the US?”
I think the answer to that question is yes, because that would be good for China also. I am optimistic.
LC – from the web:
” Market fundamentalism (or free-market fundamentalism) is a term coined by George Soros, to criticize the philosophy that the free market is always beneficial to society. As a pejorative term the people and organizations the term is intended to refer to will generally reject the label. The meaning can be considered economic liberalism or laissez-faire capitalism taken to an extreme. ”
I was using the term somewhat loosely, referring to capitalism as free as possible from regulatory constraints or market imperfections (e.g. pegged exchange rates; trade protection measures; asset protection measures), and capitalism that essentially ignored or assumed away externalities created by markets.
Market fundamentalists would tend to promote free trade at all costs, including situations obstructed by intransigent foreign XR pegs, and including open season on all type of US assets for anybody who has the money to buy them (with ‘national security’ perhaps being a constraint).
I think Soros uses it in the sense that market fundamentalists assume the world should operate in the way they ideally want (unfettered capitalism), but that they are somewhat naive in expecting this.
One application in this case is the expectation that China can ever act quickly enough on changing the peg, in order for that alone to be the resolution to the issues that the peg has created.
Anonymous:
Thanks.
“One application in this case is the expectation that China can ever act quickly enough on changing the peg, in order for that alone to be the resolution to the issues that the peg has created.”
Hmmmm…. a lot of food for thought.
LC -
Another very interesting example of market fundamentalism would be the view that the Fed and the Fed funds rate should be abolished, and all rates including the short rate should be market determined.
If somebody ever wanted to do a post generating about a 1000 comments, that would be a good one.
Gillies again distills the essence of the argument most succintly.
I’d add that large private diddlers of the market or the market structure for parochial gain remain beholden to authorities who can – in order to preserve the game – change the rules of the game for the sake of public interest. Moreover, even in collusion, large private interests are for the most part still in the extreme at the mercy of the market as a whole. So even as concentration grows, the game remains tolerably efficient.
However, when the diddlers are public authorities, be they Central, Banks (BoJ PBoC), toadying SWFs (Kampo, SAFE), or partial or fully-owned SOES (Gazprom?), there is little systemic ability to restrain pursuing unbridled parochial self-interest at the expense of the integrity of system itself. And so the game itself becomes wholly compromised, with player’s reverting to unilateral means to achieve selfish ends, irrespective of externalities, rather than deferring to multilaterally-written boundaries of the game.
For all DCs bias and ranting, he IS correct in assigning reasonable blame upon US. There undoubtedly are (and have been) many means available to moderate and/or throttle US private consumption, and energy imports, and the policy failures of not doing so through more responsible fiscal policy & energy policies will have profound impacts for a generation. The articulate “Anonymous” comes closest to my view that an administration truly concerned with long-term economic interests, domestic US inter-generational fairness, sympathetic with preserving global systemic integrity would have long-ago moved to counter overtly mercantile policies from east Asia that diminsh the integrity of the markets as allocators of resources, and the international financial system for the sake of mercantile advantage.
The less overtly protectionist policy response for the US is tighter fiscal (particularly via consumption and Energy levies) and looser monetary policy that at once diminshes the major source of goods deficits as well as the attractiveness of holding excessive USD reserves, and the ability of say Japan to cynically use monetary as a stealth alternative to overt reserve accumulation to prevent appreciation. IF, the US is serious, then they too must be prepared to sacrifice, and adjust accordingly.
Finally, there is no excuse for lack of transparency into the ultimate source of “hedge funds” capital. If ADIA, Temasek, SAFE or Russia are using HF’s as cover for deploying sovereign funds less-than-soberly, CBs, regulators and the public have a right to know. Imagine SAMA and Russian Funds using Centaurus or Brian Hunter as cover for strategies that are meant to manipulate prices under the guise of benign SWF investment. After all, there are many commodities and instruments where the larger private contracts are struck upon the often less-liquid public market prices, and as was the case with Enron in power markets, and Kraft and cheese, concentrated interests can (and too frequently do) abuse market power for dishonest means. If SAFE is 25% of a Blackstone buyout fund, and upon PE buyout jobs are moved to China, The People should be told….
bsetser: Calpers follows US rules, is accountable to its beneficiaries (though like all money managers, imperfect) and works with the established US market ground rules.
And this is going to be true with any Chinese fund that invests in the United States. There is a reason that the investment to Blackstone was limited to 5%, and that was because that is the limit at which a lot of SEC rules kick in. The trend with Chinese companies has been to try to work under US or HK rules since that encourages confidence and investment.
The Chinese government has had a lot of experience in how not to run an investment fund (there was a corruption scandal in Shanghai recently). The reason it has bought into Blackstone and Barclays is because they realize the need for professional fund management.
bsetser: it needs to find more jobs, not less to address the fall in labor income in china.
What fall in labor income? Aggregate income has been rising. There is a problem with regional income distribution and a problem with provision of social services, but that is a different issue.
As far as currency losses. I met someone who was of the opinion that if China were to loosen capital restrictions that there would be an outward flow of capital which would keep the RMB from rising too much. The point was that NY assets (both stocks and real estate) right now are far cheaper than Shanghai ones.
As far as not losing money to do stupid investments, why do you think the Chinese government bought into Blackstone anyhow?
[q]Finally, there is no excuse for lack of transparency into the ultimate source of “hedge funds” capital.[/q]
Once investment in a public company goes above 5%, then all sorts of disclosure laws come into effect. People that want to keep their investments private try very hard to avoid hitting that 5%, which means that they have very limited impact on corporate policy.
What I find ironic about all of this is that during the 1990’s, the “free traders” were all for currency pegs, the theory being that a currency peg would discipline bad government policies.
Also bank lending rates have been kept low in large part to recapitalize the banks. As with a lot of my disagreements with Brad, this comes down to “bad as compared to what.”
If bank were forced to pay more interest and as a result the banks went under, this would hardly be a good outcome for small savers. If banks didn’t loan out money to state-owned enterprises, then you’d have people with no safety net once they were laid off, all ready to riot. This would also not good.
One could think of the low interest rates as a tax to fund the cost of paying unemployment insurance to the people laid off by the state-owned enterprises.
i should have been clear; i meant labor income relative to GDP.
cassandra — could you spell out a bit more clearly what you mean by the integrity of the system as a whole. i think i know what you mean, but am not 100% sure …
Two more points:
1) There is no reason to think that the Chinese government seeks to undermine the economic system of the United States are act in ways that are non-commercial.
2) There is no reason to think that the current system of economic laws and regulations in the United States can’t deal with Chinese investment. Most people don’t know that the biggest shareholder in Citigroup is a Saudi prince. If the Saudis can invest $400 billion in the US, without causing the system to collapse, I doubt China will have too many problems.
I think a lot of what is happening is that Chinese investment is new and different is provoking something of a xenophobic reaction. It may be understandable xenophobia but it is still xenophobia.
I’m curious, has anyone here other than me actually talked to Chinese government officials to get a sense of how they see the world? Your typical mid-level Chinese government official looks (and thinks) more like a Harvard MBA than someone wearing a Mao suit.
Two fish –
a) Saudis don’t have $400b in US equities (unless they have a lot more private equity than I think), and there equities are spread around in a lot of different accounts (the prince, a construction magnate, the private account of the royal family — i assume — and the like). SAMA mostly holds debt, it holds a lot less than some others
b) China already has about $1 trillion in US debt
and the key thing about China is that it will be investing $400b a year in the us unless something changes. That’s the flow. add that to the $1 trillion stock and add in some capital gains and you get really big fast.
finally, china already acting non-commercially. the accumulation of dollars right now by China’s state defines commercial (in the sense of financial) logic. It is a policy that generates expected financial losses …
and there are a host of other examples of domestic non-commercial activity by the chinese state. less than in the past, but still plenty …
brad: i should have been clear; i meant labor income relative to GDP.
I can’t see the relevance of that metric. Of course the share of GDP going to corporate profits is going to increase since in the 1990’s, most Chinese corporations were Soviet-style disasters that were bleeding money.
I don’t see “keeping people employed without increasing productivity” as a useful goal. If that was the goal, then what was the point of making companies more efficient and productive in the 1990’s? If you increase productivity and efficiency, then you can set things up so that the people you make redundant should find be able to find new jobs, and get some of the benefits of productivity, and that is more or less what happened in urban China.
The problem with China is that it has to deal with success. The systems in place are designed to keep “hard currency” in China at all costs, and also assumes that Chinese companies are not profitable. One could argue that the are maladaptive now, but it takes time to change, and another disagreement I have is that I think a lot of bureaucratic inertia and wise cautious is being misinterpreted as intentional stubbornness.
[q]finally, china already acting non-commercially. the accumulation of dollars right now by China’s state defines commercial (in the sense of financial) logic. It is a policy that generates expected financial losses … [/q]
Which I strongly argue are less than the financial losses of any of the alternative courses of action. A loss of a few tens of percent in currency reserve value is minor compared to a crisis that topples the government.
Whether this is the case is debatable. What is less debatable are the motives of the Chinese leadership. I don’t think that the resistance to currency revaluation is because anyone is extremely wedded to the current system, but rather because there has been a real fear of a crisis if they change in the wrong way.
To get the Chinese government to move you need to present a scenario in which their current actions will cause rioting in the streets.
Personally, I think there *is* such a scenario which is why I think the RMB is going to move much more sharply upward in the next few months. Basically, the argument is that the Chinese government is reaching the limits of sterilization, and that it *has* to increase the exchange rate to avoid triggering inflation.
bureaucratic inertia in my view has resulted in a somewhat reckless policy — but i agree that some aspects of china’s policy regime reflect policies that were designed for a different era (i.e. when there was pressure for rmb depreciation and soes were losing money hand over first) not the current era.
on the “keep money in china front” tho a lot has changed — note the decision to let insurance cos take up to $50b out of china, and i think exporters no longer face a surrender requirement. China is now begging for more private capital outflows.
i think labor income v GDP is a relevant metric b/c one would expect the integration of a labor rich/ capital poor country into the world economy to raise labor income (v GDP) in the labor rich economy and reduce it in the labor scare economy. right now labor’s share of national income is falling in China and in the US/ Europe. that is a puzzle. the absence of stronger job growth in china (given the scale of the boom) is a big reason why.
and yes, when there is a large underemployed population (spain in 80s/ early 90s, germany today) a period of strong job growth/ slow productivity growth can be good from a macro point of view.
That “different era” existed less than a decade ago, and it takes about five to ten years to change a bureaucracy. I don’t think that moving slow is necessarily reckless, since I can’t see how in this case, the slowness of the government can lead to something that gets people in the streets rioting.
One thing that worries me about some of the economic suggestions is that they may make sense now, but will result in a system that will require “major undoing” in ten years. Chief among those is the idea that China should boost consumption and substitute labor for capital. Those policies will make no sense once people start retiring around 2020.
As far as labor scarcity. Are developed nations really labor scarce? There appear to be no shortage of people willing to cross borders to work in the US or Europe, and a lot of those people don’t show up in the statistics.
[q]and yes, when there is a large underemployed population (spain in 80s/ early 90s, germany today) a period of strong job growth/ slow productivity growth can be good from a macro point of view.[/q]
But I think that view is too blurry to see what is going on in China. Chinese agriculture is incredibly inefficient, and there are a lot of policies designed to keep things that way, in order to serve as a sink for the underemployed.
The problem with a policy that encourages industrial inefficiency is that this set up a system that is hard to undo when it becomes counterproductive. If you want people to be inefficient, there are easier ways of doing it (like paying them to do nothing useful).
I’ve been trying to come up with “core disagreements” and I think one of them is the idea that somehow capital “should” be moving from the United States to China rather than the reverse. I suspect that models that argue that this “should” be the result, don’t take into account differences in efficiency of financial systems.
(If someone can point me to a paper or economics textbook where this argument is laid out, I’d be appreciative, since I’d like to write a paper arguing that it is wrong.)
One thing that I think will happen if the RMB appreciates and capital controls on outflow are relaxed is that there will be a huge buying spree since US assets are cheap by Chinese standards and even cheaper if you appreciate the currency.
Twofish:
Yes, I have talked to Chinese officials. While I don’t think they’re all Harvard MBAs, they do care more about economic policy than their western counterparts and seem fairly well informed.
I agree with your point about capital flow, but conventional wisdom seem to be developed nations should be more altrustic and help the poor nations.
I do have a slight point of disagreement regarding outflow of RMB though. If the controls are relaxed and currency appreciates, there would still be some protectionist calls for US assets. Look what happened last time Japan appreciated and wanted to buy some real estate.
I’d also like to get your opinion on Chinese inflation. Do you think it’s equivalent in all regions of China?
There are so many problems with the model that developed economies export capital that it could only work on paper. Private capital would charge exorbitant rate for taking on “risks”. It just happens risks appear very differently to those that are bound by their borders from those who could simply leave. The development agencies (World Bank etc) are supposed to help but one would be hard pressed to find examples of success (outside of places that could succeed on their own anyway). And capital mobility in the name of maximizing profit, while can provide discipline, also can wreak havoc on the local economies. Adding salt to injury, the problem may have started with hot money rushing in seeking quick profits in the first place. In the end, people are bound by national borders. Pretending that goods and capital can be independently mobile while people are not is bound to lead to policy failures.
One more thing that’s at the core of this debate: what is the definition of the global financial system? If the system is defined as constituting solely US, European financial markets and assets, then yes, Brad, Cassandra (and others) have a point. The large inflow by the non-members, e.g. Russia, China and Japan will be problematic and compromises the integrity of the system.
If the system is defined as inclusive of all global capital, including the reserves from EM, then the inputs will be less problematic and the new comers have a tremendous amount of interest in the maintenance of the sytem. (Though I believe the new comers will also care about the integrity of the narrower definition of the system, per Twofish’s point.)
LC – What an exchange of opinions turned out in today’s post! My take on whether there’s a single or hybrid (domestic and international) global economic system at work, be it wholly or somewhat integrity balanced is not that relevant, for the core breaking down of the system starts once “earth’s resouces” hit the declining point pitting “have most vs. have some vs. have little or none” and highjacking it. That’s why I feel so strongly that “human advancement aim” should never be about where or how much one’s goods or capital has or flowing, but should about having the minimum decent meals, shelter, social interactions and recreations for all.
By systemic integrity, I meant to follow gillies path of “the game” being the efficiency with which markets operate allocate resources – which to great extent still follows the elementary BW boundaries. Throw these away, and the international monetary system can become a cynically slippery slope. Japan and China (and the USA) have pushed well beyond beahavioural boundaries that would have afforded comfort to Keynes or Triffin.
even informed (if unverifiable) assertions may not be true… esp on the internet. what is the quality of your information? can the US have china’s assurances? and in writing… without a very functional legal system (nor a strict adherence to rule of law), how will it be enforced?
what if the US were to bring political pressure to bear, say on documented human rights and environmental abuses, much less political (taiwan, tiananmen, tibet) and religious (falun gong, the pope, panchen lama) freedom, or technology transfer/sales/aid to iran and pakistan?
recently china has shown that it is not immune from political pressure (food/product safety, darfur) but their responses appear belated, haphazard and almost grudging, if only because they were preventable and yet they weren’t…
china still lacks internal controls and the ability to self-regulate (not that the US or any other country is without room for improvement) hence if not imposed from within it will, eventually, be imposed from without, as it has always been…
relatively uncontroversial, but while the world is justifiably thrilled at china’s rise, ‘peaceful development’ and commitment to progress, it is also wary that china’s brand of growth masks significant compromises and risks that could yet prove malignant and ultimately unsustainable. do they not deserve a proper hearing? this forum provides one, but i think it will get a lot larger…
My definition of system includes emerging economies.
the private flow of capital is now as strongly toward emerging economies as before the asian crisis (see the ADB report, or the IMF report).
I don’t have a reference on hand but as Treasury Secretary Dr. Summers made the argument that capital should flow from rich (in capital) to poor (in capital) and from the aging to the young. China is a bit of a strange case b/c its demographics differ from that of other emerging economies, but if you think of urban migration as increasing the urban labor force, it still clearly has a rapidly expanding labor force — unlike say japan.
until the current pattern of capital flows emerged, i know of no theory that argues that the governments (remember, this a government flow) of poor countries should lend to consumers/ households/ governments/ firms in rich countries.
the current flow of capital is something very new (china only started to run 10% of GDP surpluses recently) and to my knowledge unprecedented.
if it may be more accurate to rephrase it as ‘rich governments’ of poor countries lending to relatively rich countries – although your definition of ‘rich’ country also seems to be somewhat conflicted – at least to me.
perhaps along with the definition of ‘lending’…
i don’t know that a ‘vendor-financing’ development policy has ever been tried before, but there has been cases — e.g. ‘company towns’ — whereby easy financing is extended as a hook to eventual foreclosure on assets. if this can be extended to the US’ situation, the US is definitely on the easy-financing hook, whether its assets (technology, institutional know-how) can be ‘foreclosed’ upon now remains to be seen…
they don’t need to foreclose upon technology & know-how….they’ve historically acquired it much more simply and cheaply by stealing it. Even the Japanese have extremely heightened awareness about the amount and access of IP in their industrial transplants
which may also lead to the current reality that many of the so-called poor nations have established sizable populations in the ‘rich’ countries, and that, in addition to the interest payments and tech transfer, dividends also include 10’s of billions of dollars worth of annual remittances.
Brad,
I agree that it is strange that EMs are financing developed economies. It is not desirable and it is reflecting policy inflexibility designed for another era. However I also don’t think developed economies financing EMs model works either. The failure of this conventional model created the old inflexible policies of EM.
Both China and India have high domestic savings and a large well-to-do diaspora (bringing in investments different from typical investment flows).
HZ — i think we both would be more comfortable with more balanced current account positions. agree that the 90s suggest that relying on portfolio flows to cover EM current account deficits (big ones at least) is risky, tho perhaps those risks have fallen as demand for local currency assets has increased.
lending may have been a bad term, tho it is accurate for the majority of current flows. equity investments to date have been small.
rich is accurate. apart from a small number of oil exporters (UAE. Kuwait) the average per capita GDP of those countries whose governments are financing the US is well below the US/ european level.
and i think would once again encourage those posting (regularly) as guest to pick a handle …
“…Indian Americans are the second largest Asian American ethnic group following the Chinese American community. Indians own 50% of all economy lodges and 35% of all hotels in the US, which have a combined market value of almost $40 billion… One in every nine Indians in the US is a millionaire, comprising 10% of US millionaires… A University of California, Berkeley, study reported that one-third of the engineers in Silicon Valley are of Indian descent, while 7% of valley hi-tech firms are led by Indian CEOs… Indians along with other Asians, have the highest educational qualifications of all ethnic groups in the US. Almost 67% of all Indians have a bachelor’s or high degree (compared to 28% nationally). Almost 40% of all Indians have a master’s, doctorate or other professional degree, which is five times the national average…” http://en.wikipedia.org/wiki/Non-resident_Indian_and_Person_of_Indian_Origin
“…Regions with significantly large Chinese American populations include San Francisco, San Gabriel Valley and Silicon Valley in California and the Tri-State Region… of the East Coast… Areas with growing Chinese American populations include southern Orange County, California, Edison, New Jersey, Plano and Richardson, Texas….” http://en.wikipedia.org/wiki/List_of_U.S._cities_with_large_Chinese_American_populations