Still not working
China indicated back in the 2004 that it wanted to rebalance its economy, and shift away from export and investment-led growth.
Despite a common perception in the US business community that China’s leadership can do pretty anything (economically speaking) that it wants to do, it is increasingly clear that the policies China has adopted to try to rebalance its economy have not worked.
The World Bank’s most recent quarterly update on China’s economy report notes that net exports will contribute as much to China’s growth in the first half of 2007 as in the last half of 2006:
“The external contribution to growth remained high … Our estimates … suggest that the contribution of net external trade to growth remained at the high level of the second half of 2006, contributing over one-fourth of overall growth” (Figure 1 of the quarterly has the details).
China’s current account surplus is projected to rise to $380b (12% of China’s GDP) – even with very high oil prices. That is an increase of $300b (and 8-9% of China’s GDP) since 2004. If the US had experienced a comparable swing — relative to its GDP — in its current account balance, it would be running a substantial surplus now.
Incredibly, the rise in the current account surplus (an excess of savings relative to investment) has come even in the face of strong investment growth. Sure consumption growth is strong, but consumption is such a small share of GDP that even strong consumption growth contributes less to overall GDP growth than might be expected – especially when consumption is growing more slowly than investment and exports. The World Bank notes that “almost all of the variation in domestic demand growth recently has been driven by investment, including the upturn in the first half.”
The World Bank notes that China’s surplus the “external imbalance remains the main macroeconomic issue” that China faces. China’s steadfast defense of a very modest pace of appreciation against the depreciating dollar influences almost every other aspect of China’s economic policy.
But China’s huge external surplus isn’t just an issue for China. China’s policy choices are shaping how the global economy adjusts to the US slump. That slump – and the associated weakness in the dollar — has already pulled down the US non-oil trade deficit a bit. But the main impact of dollar (and RMB) weakness has been an increase in China’s trade surplus.
And while the US economy needs the boost from the external side right now, China’s economy doesn’t. Basically, China’s continued de facto quasi dollar peg — China broad exchange rate has actually depreciated recently, as the RMB’s rise v the dollar hasn’t offset the dollar’s broad fall – has redistributed some of the external boost from dollar weakness from the US to China.
The Chimerican aggregate external deficit is falling. But it is falling because China’s surplus is rising and the US deficit is constant, not because the US deficit is falling. Recent improvements in the United States non-oil trade balance have been largely offset by a rise in the United States oil import bill.
The result: China increasingly is using lending the surplus it earns selling goods to Europe to the US, not just lending the money it earns selling to the US back to the US.
On current trends, China will run a $260b or so bilateral trade surplus with the US, and a $380b global surplus. It also will likely lend the US $350b or more of its $500b in reserve growth.
China will be lending the US significantly more than it makes selling to the US for the first time.
That, I suspect, is something that is likely to continue in the future. It has a corollary as well: The gains to China from financing the US are falling, while the costs China has to bear to support the US are rising.
The standard argument that China would shoot itself in the foot, financially speaking, if it stopped lending to the US is wrong. China would certainly shoot its export sector in the foot if it stopped lending to the US. And it is true that if China stopped lending to the US, the value of the RMB would rise relative to the dollar and the value of China’s existing US assets would fall. But China would still be better off, in the purely financial sense, if it took its lumps now.
Remember, China has to buy an awful lot of dollars to keep from taking losses now. It is has to do more than hold its existing position. It has to add to its position.
And the more dollars China holds, the larger its ultimate losses.
Every time China’s government borrows in RMB to buys another dollar – a dollar that is almost sure not to hold its value relative to the RMB – it shoots another hole in its balance sheet …
No doubt, those betting that been that China would be willing to pay an ever-growing price to maintain stability in the US bond market have made the right call over the past few years. But those making the bet are betting that China will continue to prioritize the interests of its export sector over its own long-term financial health, and perhaps domestic macroeconomic stability as well. It is a reasonable bet. But in my view, it isn’t quite a slam dunk.
“The top 20 earners among private equity and hedge fund managers are earning average yearly compensation of $657,500,000, with four actually earning more than $1 billion annually. The otherwise excessive $36,400,000 average annual pay of the 20 top earners among CEOs of publicly-held companies looks paltry by comparison.” - Paul Craig Roberts
In the last gilded age of the 1920’s, at least we had American industrialists that built railways, steel mills, oil refineries, automobile factories, mines, etc. The Rockefellers actually built real stuff. Now we have Wall Street hacks led by Robert Rubin and Hank Paulson from Goldman Sachs that have never produced a damn thing in their entire lives, bankrolling their billion dollar fortunes through unregulated paper manipulation, and controlling the democratic and republican parties, respectively with their political campaign contributions. Paulson earned his personal fortune selling the AAA rated, toxic waste CDOs to pension funds across America. Citicorp’s Robert Rubin earned millions from his personal involvement with the criminal enterprise otherwise known as the Enron corporation. I am so sick of this BS of financial fraud and corruption. And Brad, at least the Chinese do actually produce stuff.
The price of a pig - Allowing faster renminbi appreciation would damp down imported food prices and reduce accumulation of foreign exchange reserves.
Currencies: Still hanging on - How far, and how fast, will the dollar fall?
“…Copycatting is, of course, easy, costs less, and is less time consuming. In an effort to make quick profits easily, manufacturers and businessmen in developing countries like… China now, are producing counterfeit products… In other words, greed coupled with nationalistic pride is spurring manufacturers, big and small, to produce goods that look as “good” as those made in advanced countries even if it means violating international laws against copyright infringement. But every developing nation eventually reaches the point where, using the acquired technological know-how, it should be able to make products it can truly call its own. This, of course, is easier said than done…” http://www.koreatimes.co.kr/www/news/opinon/2007/09/137_10129.html
what will be the effect China’s QDII and soon to start a trial retail version QDII not to mention CIC which are now in the process of hiring up 200 people in Hong Kong to manage 200bn
It seems that all these programs (which together could 300 -400bn over the next year) will allow money to flow out of China but it will not be going into t-bonds and bills
my view:
a) QDII = pretty much irrelevant. likely flows are still small. at current exchange rates, foreign assets are likely to be unattractive relative to domestic assets (that is my understanding of why interest so far has been modest)
b) CIC — initial impact smaller than expected, b/c CIC is likely to only have about $100b to place (b/c the rest will be central huijin/ expanded use of reserves to bailout ABC). But over time it could lead to a significant shift in the types of assets that China is buying. the WSJ article on the CIC on monday was good, and i hope to do a full post on SWFs soon.
In the hypothetical closed system of Chimerica, rural factories are making Stuff for the Information Utopians in the cities. The factory owners provide housing and food to their own enserfed workers, and the workers promise not to burn the manor house down.
The factory owners take dollars from the city dwellers, and give Stuff in return. But the factory owners have no real use for all the dollars they accumulate - they are only concerned about keeping their homes intact. Eventually, the cities will run out of dollars. What will happen then?
A) The factory owners buy services and assets from the city, like entertainment, accounting, haircuts, and large buildings. Dollars are recycled.
B) Factory owners cut prices and agree to take fewer dollars in exchange for the same amount of Stuff.
C) The city prints new dollars and gives them to the factory owners, who agree to accept them with no change.
D) The factory owners give the dollars back to the city, and then provide more Stuff in exchange for the same dollars over and over again.
or…
E) The factory owners invite their workers to set fire to the pile of dollars, and tell the city dwelling Utopians that the whole dollar-shifting-thing is a waste of time. Instead, the factory owners will just provide lots Stuff to the city, for FREE.
Perhaps the best way to figure it out is to ask, in the absence of (A), what good is a big pile of dollars to the factory owners? Because if (A) isn’t an option, (B), (C), and (D) are all indistinguishable from (E).
And if (E) is the way things work out, I think I’d like to live in the city.
re: “the WSJ article on the CIC on monday”
Jesse Wang was at the FRBSF conference last week — http://www.frbsf.org/banking/asiasource/events/2007/0709/agenda.html — saying they want no involvement from CFIUS which limits them to mainly small (~5%) public equity stakes thru 3rd party asset managers/hedge funds; also when asked they have not yet formulated an investment policy or asset allocation procedure yet…
It is the United States in the coming decade that will certainly have to adapt to a multipolar world in geo-economic terms, as China and India will reoccupy the central place in the global economy that they had 200 years ago. It is the Washington Consensus that needs to rebalance the U.S. economy from Rubin Neo-liberalism “for only the elites” to a more equitable “regulated capitalist” economy that better distributes prosperity to the entire population. Don’t expect Chinese civilization which is older than any other on the planet to ever become a mirror image of the United States. Even though the rest of the world may frequent McDonalds and drink Coke soft drinks, that doesn’t mean they want to emulate the political and economic structures of the laizze-faire United States. The Chinese, Russians, Indians, Brazilians, Iraqis and the rest of the world don’t want to be just like Americans. Thomas Friedman, are you listening?
Vendor financing on an international scale. Time to cut the losses.
I disagree about the role of QDII’s. Now that the door has been open to QDII equity investments, the result is likely to turn into a flood especially as the RMB appreciates.
The other thing that is changing is that Chinese reserve growth has finally I think reached its limits. The possibility that China may have bad central bank balance sheets at some point in the future is not going to cause any major policy changes. The fact that Chinese inflation is picking up, will cause major policy changes.
The hostility that David Chiang has toward Wall Street is odd. Right now people here are anxiously awaiting the massive flood of money that is going to come out of China once QDII gets going. Take US$400 billion, remove just a tiny bit off of the top, and you got big, big bonuses.
(Also the numbers that hedge fund managers make is very misleading. Most of those huge numbers are in shares of the hedge fund which they cannot easily sell, and which would be worth a lot less if they did.)
We shall see on the QDII. so far it has been a bit of a flop. Certainly the street is eagerly awaiting a flood of chinese money, whether from domestic financial institutions or from mandates to manage a share of the CIC’s funds.
Twofish,
No doubt the Wall Street banksters are salivating at the prospects of selling the Chinese more of their AAA rated, MBS and CDO toxic waste crap. After the majority state-owned Bank of China reported a multi-billion dollar loss provision on its AAA rated subprime bond portfolio of $10 billion, the Chinese may not turn out to be so enthusiastic buyers the next time around. Fool me once, shame on me, but try to fool me twice, shame on you. The Germans, Chinese, and French won’t be swindled so easily the next time around by sweet talking Paulson.
Twofish,
even if you don’t get a piece of the $400bn, it’s going to push asset prices up. This rising tide will lift many boats.
Just like Chinese cash gave Americans wonderfully low interest rates, now Chinese cash is going to give Americans a few extra points on their portfolios.
Keep it up! We’ll have the printing presses running all night to meet that demand!
Crude oil prices settled at a new record high of $80.09 a barrel today on the New York Mercantile Exchange.
Can anyone at the Federal Reserve state with a straight face that “inflation is absolutely NOT a problem” with their “core inflation” hedonic statistics that excludes energy, food, commodities, and any other items that rise in price.
Uh oh Dave Chiang, better get to defending the Chinese. Can you read a single article/essay put up by Dr. Setser about Chinese economic policies, the Chinese-US economic relationship, or Chinese investments without considering the article or essay an attack on China?
Brad Setser, what are the estimates for negative effects on GDP from China “importing” pollution due to the build up of their manufacturing sector? I have seen numbers that range from -3.5% to -14%. That seems like too wild of a swing. The development of China’s economy has been one of the greatest tools in bringing millions out of poverty, but at what health and environmental cost.
I work in the US manufacturing industry managing ops dept of a capital goods manufacturer. We had a major evaluation of operations to determine if we should keep a specific part of production in the US. We have relocated inside the US, but kept precious manufacturing jobs stateside. Several of my family members also work in manufacturing at various firms, and despite all the calls from folks like Peter Schiff or Michael Panzer, yes, the US still does ‘produce things’. The trade imbalances and currency over/undervaluations if allowed to float freely, would allow for our goods to compete more and allow for resources and capital to be deployed in precious manufacturing here in the US. There would be massive short term pain due to the adjustment to currency value, but in the long run it would be good for all sides.
Anonymous — Appreciate your comment; I am glad to see that the blog isn’t just read in the financial sector. I am afraid though that I am better at estimating the likely losses associated with China’s dollar holdings than the costs associated with “importing pollution”. The BBC this morning was reporting that china now has an unusually high level of birth defects (if my hazy memory serves), which strongly suggests that not all the costs are economic.
“Just like Chinese cash gave Americans wonderfully low interest rates, now Chinese cash is going to give Americans a few extra points on their portfolios.”
Funny, according to jkh in previous post, U.S. domestic banks are the ones churning out loans with low interest rates (not China’s $ trade surplus reserves).
What’s going to give Americans higher portfolio returns (which has been mentioned many times in this blog) is to invest $ overseas.
Anonymous,
Almost 60-70 percent of Chinese exports to the United States are by US multi-national corporations. Apple, IBM, CISCO, Hewlett Packard and many others outsource the manufacturing of their products to Chinese subcontractors. It is entirely the decision of US multinational corporations to outsource their production and even development of products. The Chinese are not responsible for the gaping US-China trade deficit created by America’s Fortune 500 corporations.
So here’s my question. Suppose, as seems increasingly on the horizon, the U.S. enters into a recession: does China maintain the $ quasi-peg and go down with the $, even as U.S. demand for its exports is likely to decline, thereby increasing its exports to Europe, and mightly pissing off the Europeans through further import penetration there, or do the Chinese increase the rate of Yuan appreciation, as they begin to accumulate fewer $ in proportion to Euros? And then what do the Chinese do with their vast accumulation of $, with the depreciation and capital losses, (due to presumably rising U.S. long-term interest rates)? Even if they do increase the rate of appreciation, this will have to be managed, so as not to disrupt the whole international system, so they’ll have to accumulate more, if fewer, U.S. assets still. Then what do they do with their store of depreciated dollars? Do they begin to buy high-end capital goods from the U.S. rather than Germany? (Is our remaining engineering as good as Germany’s anymore?) Do they begin to buy up U.S. raw material commodities and productive assets at rock bottom prices? Do they open up warehouse lines of mortgage credit once housing prices bottom out? It seems to me depreciated dollars can’t be spent anywhere else without not only realizing full capital losses, but worsening their already depreciated value.
Brad Setser,
I will look for that BBC article. Your article about Chinese leadership not having iron fisted, top down control as depicted elsewhere is what worries me about environmental plans the leadership wants to implement. The more I have read about environmental problems in China, the more it makes sense that no news stories show the Shanghai skyline during the daytime. Environmental concerns is a small but growing approach with investors about where to fund capital expenditures.
Despite being disparaged by most CNBC and financial website types, the American manufacturing industry is cognizant of global competition and forever trying to stay ahead of the curve. Information is always a great weapon to have. I consider reading essays such as yours as a way of staying up on my intra-office coworkers as wel as other firms. Worth more than the Art of War required readings my boss had in B-School.
DC — do you really think that the RMB/ $ (something under China’s control) has had no impact on the decisions of US MNCs?
Guest — good questions. i would be interested in your answers. you are right that depreciated dollars (especially the existing stock) cannot be easily spent outside the dollar zone without putting more pressure on the dollar.
“The BBC this morning was reporting that china now has an unusually high level of birth defects (if my hazy memory serves), which strongly suggests that not all the costs are economic.”
I’m a small(once upon a time quite larger) sporting goods manufacturer California I can assure you that demand may not be purely economic either. My export biz boomed in Japan and Australia pre 1997. Post 1997 in the strong dollar global economy?….nothing of course. We have transfered manufacturing technology to Indonesia and now bring our low and mid priced product from there. High end , “Made in America” expensive stuff? We export all over the world but to a very limited niche market. If we had to depend on that to pay the bills….good luck!
There is no foreign market that I know of that *needs* anything from the US that can not be made there or imported from Asia. GOOD, high quality stuff too. Been to Thailand or Malaysia lately?
IMO…… a weak dollar is no longer the answer to ANYTHING.
Take your medicine.
Geppeto
Anonymous: The problem with translating pollution and health effects into GDP losses is that one is comparing apples and oranges. Essentially you have to put a value on human life and human health, and it is not clear how you can do that in any sensible way.
If the USD drops sharply against the Euro, the I don’t think the RMB will fall with the USD. Ever since the peg broke, the RMB has been fixed to a basket of currencies.
To DC: Wall Street is willing to sell whatever financial products China is willing to buy. Want more risk? Want less risk? Gold? MBS? Stocks? Bonds? What ever is your fancy then there is a product that can be created to sell to you.
The nice thing about the relationship between US banks and Chinese investors is that you are seeing lots of fun and games between nations with smart and powerful people on both sides. It’s more fun than watching professional wrestling.
Twofish,
The $10 billion in subprime MBS that Wall Street sold to the Bank of China were rated AA by S&P and Moody’s. With the blessing of US bond rating agencies, those subprime MBS bonds were marketed as extremely low risk investments. In retrospect, with several billion dollars in paper losses, perhaps the Chinese should not have be so trusting of the Wall Street banksters. Nevertheless, the marketing of subprime MBS toxic waste bonds as AA and AAA investments almost on par with US Treasury bonds safety constitutes criminal fraud, pure and simple. The Bank of China was never looking for a high risk investment; what they received were toxic waste junk bonds at an US Treasury bond yield. Where are the US government regulators, SEC, and federal law enforcement officials?
I believe DC is incorrect about India’s potential. The infighting among the Hindus and the Muslims, the rigid cast system, the almost non-functional infrastructure, the massive pollution and the projected 1.3 million increase in population from 2005 to 2015 (+40%) will not bode well for India’s future. Almost anyone with the means to get out of India by 2015, will probably do so.
The BRIC countries, not including Brazil, are largely responsible for dirtiest, most polluted living conditions for its citizens. For proof, check out this map that lists the 30 dirtiest cities in the world:
http://www.blacksmithinstitute.org/ten.php
brazil has its own problems: “Brazil’s President Luiz Inacio Lula da Silva has announced a plan costing over $3bn to tackle the high levels of crime in the country’s cities… Brazil has one of the highest murder rates in the world…” http://news.bbc.co.uk/2/hi/americas/6956089.stm
(Shanghai Daily): 2006-06-06 08:30 - “China’s pollution problems are costing the country more than US$200 billion a year… Environmental damage is costing the government roughly 10% of the country’s gross domestic product… Despite the efforts of half a million environmental officials in his agency and other organizations, China’s environmental picture is worsening and “allows for no optimism,” he said as he issued a report that described the situation as “grave.”…” http://www.chinadaily.com.cn/china/2006-06/06/content_609350.htm
July 23/07 - “China has indefinitely postponed the release of an environmental report on the costs of economic development…” http://news.bbc.co.uk/2/hi/asia-pacific/6911784.stm
The trade surplus means ultimately that China delivers real things in exchange for paper (part of which is then exchanged for promises to receive yet more paper in the future).
That makes sense as long as:
- you need that paper to pay previous debts, which I think is not China’s case.
- you expect to buy/do real things with that paper some time in the future (e.g. buy crude oil after they’ve built their strategic petroleum reserve, buy natural resources companies in Africa and build infrastructure for them.)
Now, there is a point in which there is so much stored paper that it becomes impossible to exchange it for real things. It’s foolish to keep running a trade surplus after that point. Similar to the case of someone still working 10 hours a day after having amassed more wealth than he and his offspring can ever spend.
Twofish: The nice thing about the relationship between US banks and Chinese investors is that you are seeing lots of fun and games between nations with smart and powerful people on both sides. It’s more fun than watching professional wrestling.
It may be fun and games to men who warm seats on Wall Street all day for a living but it is no game to a billion men and women who earned those dollars with their sweat. Wall St may be providing a service by creating products suitable for the Chinese but that doesn’t they are not picking their (i.e. the Chinese’) pockets at the same time.
Re: QDII
Brad,
On a valuation basis, it seems much safer for the Chinese investors to diversify from the Shanghai and Shenzhen exchanges despite the exchange risk. And they could buy Chinese companies listed on Hongkong and other overseas exchanges without getting exposed to the CNY appreciation risk.
Many large financials in the West are trading at over 10% earnings yield and over 5% dividend yield. These are just crying out for deep pocketed investors unconcerned with liquidity issues. And investment in the sector should be a lot less sensitive than, say, the technology sector, and will have much better return in the long term as well.
DC: In retrospect, with several billion dollars in paper losses, perhaps the Chinese should not have be so trusting of the Wall Street banksters.
The CDO’s that the Bank of China bought shouldn’t have caused several billion in paper losses. As far as trust, when someone tries to sell me something, I listen but I’m not going to take his word on everything.
DC: The Bank of China was never looking for a high risk investment; what they received were toxic waste junk bonds at an US Treasury bond yield.
If this was the case that the Bank of China needs to fire the people that made that decision. There are lots of people in the world that need protection. The Bank of China is not one of them since the Bank of China has the money to hire people that can question what the salesmen tell them.
DC: Where are the US government regulators, SEC, and federal law enforcement officials?
Protecting people who need to be protected. If you try to sell a security to the general public, you have to go through a lot of hoops and government regulations all designed to protect people who do not have the knowledge or resources to make good decisions. If you are a millionaire or the Bank of China, you don’t need government protection. The government has better things to do with its limited time.
In particular, it’s kind of silly for China to believe that the US government would act in China’s interest, and protect China from bad investments. The US governments acts more or less in the interest of the United States. China is fortunate in that it has the intellectual and political resources to protect itself. Other nations, aren’t quite as fortunate.
Guest: It may be fun and games to men who warm seats on Wall Street all day for a living but it is no game to a billion men and women who earned those dollars with their sweat.
The question is that at the end of the day do good things happen or do bad things happen. It’s in the financial interest of Wall Street to have China (and India and Russia and Africa) become filthy rich, because the more rich people there are in the world, the more people will need help in taking care of their money.
Guest: Wall St may be providing a service by creating products suitable for the Chinese but that doesn’t they are not picking their (i.e. the Chinese’) pockets at the same time.
First of all, Chinese are all over Wall Street. If you go into any investment bank or hedge fund and see who works there, you see lots of Chinese faces. (This is because banks are looking for physicists, mathematicians, and engineers.)
Second of all, that’s what makes watching finance fun. You have a room of smart, driven people all trying to make money off of each other. As long as people are evenly matched. It’s fun.
It’s like watching two professional boxers trying to knock each other out. If you are talking about an IB versus Zambia then it’s a professional boxer fighting an eight year old. Not fun at all to watch.
We have reached the point in history that no external force can stop China’s rise to power. China’s rise to power could be halted by internal forces, but that’s something different. Wall Street and the big multinationals have figured this out, and they are trying to get a piece of the action.
HZ — your portfolio diversification argument is fairly compelling, I should have given that point more weight in my thinking. I would still think that a chinese investor smart enough to recognize the benefits of portfolio diversification (and selling high/ buying low) would prefer non-US equities to us equities, all other things being equal, given the currency risk. Another emerging asian market that might rise in // with the RMB seems like a better bet.
Twofish: First of all, Chinese are all over Wall Street. If you go into any investment bank or hedge fund and see who works there, you see lots of Chinese faces.
This is not relevant. Wall St hires whoever will help them make the most money. In this case they may hire employees of Chinese descent to help them make money off the Chinese government and others. It is sad to see Chinese employees assisting in the looting of their own people but thats what seems to be happening.
Twofish: Second of all, that’s what makes watching finance fun. You have a room of smart, driven people all trying to make money off of each other. As long as people are evenly matched. It’s fun.
You live in a make-believe world where things work as intended. In the real world finance is MOSTLY a zero-sum game. And the game is rigged heavily in favor of some players. It is not funny when some bureaucrat at the Bank of China buys into toxic waste securities fraudulently packaged as AAA. It is a tragedy.
Guest: This is not relevant. Wall St hires whoever will help them make the most money.
You say that as if it is a bad thing……
Guest: In this case they may hire employees of Chinese descent to help them make money off the Chinese government and others.
And after a few years on Wall Street, a lot of those people end up back in China working in rather high paying/high status jobs with the Chinese government and Chinese banks. In doing so they carry a lot of their knowledge with them.
This is also why I think that the United States has a bright future. The US welcomes the best and the brightest from all over the world and turns them into flag-waving Americans.
Guest: You live in a make-believe world where things work as intended. In the real world finance is MOSTLY a zero-sum game.
First of all, the amount of money that the bankers make is a tiny fraction of the money that gets handled. If you have trillions of dollars moving through the system, the fraction you have to take in order to have more money than any human being can imagine is tiny. Second, finance is really hard work. A person puts money in savings account. You don’t think that this money goes into the back room somewhere and magically grows. It looks that way, but it’s an illusion.
The thing about financial systems is that most of the time people don’t realize how complex and how hard things are. The just stick their card in the ATM, and bits of green paper come flying out. If the people who are working in finance do their jobs, you don’t have to worry about something going wrong.
Guest: And the game is rigged heavily in favor of some players.
It is rigged in favor of people who already have money and skills. This is a huge problem when you talk about Zambia or Ecuador. It’s not a problem with China or India. They are both learning to play the game, and there are quite a few tricks that they could teach Wall Street. Both China and India have very deep commercial and scientific cultures as well as functioning governments with enough guns to anyone from doing anything really nasty to them.
Guest: It is not funny when some bureaucrat at the Bank of China buys into toxic waste securities fraudulently packaged as AAA. It is a tragedy.
It’s a tragedy when a peasant loses his life savings or when an industrial worker gets laid off from the only job they have ever known. When some bureaucrat does something stupid, it can be funny because it’s terribly unlikely that something seriously bad will happen to that bureaucrat. It’s only tragic when his mistakes start hurting other people, and this does not seem to be the case with CDO’s in China. (There are some pretty serious issues with the people that were hoodwinked into taking out mortgages that were awful for them in the US, however.)
Sympathy is a very limited quantity, and I try to reserve my sympathy for people who deserve it, and even then it is hard because there is so much awful stuff going on in the world.
The poor and the helpless, I feel for. Some middle manager in a bank who doesn’t have the common sense to avoid investing in things that they don’t understand, I laugh at (as long as the systems are in place so that his mistakes don’t hurt the people that don’t deserve it). If BOC wants to avoid these sorts of silly things happening, it is perfectly able to open up its checkbook and hire away the people that were working on Wall Street.
It’s really not that hard. Find they guy that was selling you derivatives, pay them 20% more than their previous employer, sit them in a room, and then say “ok, now you are working for me, tell me all the stuff that you weren’t saying when you were on the other side of the table, and by the way, all of the tricks that you learned working for the other guy, you can use for me now” Zambia and Ecuador can’t play this game, but China and India can.
At the end of the day, it’s about ending world poverty so that this guy in a funny hat and beard who is now somewhere in the Pakistan / Afghan border, doesn’t win. About six years ago, he attacked New York because he (correctly) figured out that Wall Street is his biggest enemy to that keeps him from imposing his vision on the world.
Guest: This is not relevant. Wall St hires whoever will help them make the most money.
Twofish: You say that as if it is a bad thing…..
But it IS a bad thing. You seem to think Wall St pretty much works like it is supposed to and for the most part those who make money on the Street earns it. But is that really the case? Unless you are willing to ask yourself that question (admittedly very uncomfortable question for an insider) you will only end up rationalizing. Just to give one example you think Wall St (and I use “Wall St” to mean the financial sector generally) only takes a “tiny” fraction of the amounts it handles. Define “tiny”.
Twofish: It’s a tragedy when a peasant loses his life savings or when an industrial worker gets laid off from the only job they have ever known. When some bureaucrat does something stupid, it can be funny because it’s terribly unlikely that something seriously bad will happen to that bureaucrat.
The bureaucrat is a mere intermediary. The savings that he blew away on some toxic CDO was created out of the blood and sweat of some underpaid men, women and yes even children in China. The Chinese govt kept some of those savings to use on their behalf but ended up losing it to some bozo hedge fund manager who imagines himself “Master of the universe” for successfully gaming a system rigged in his favor. The bureaucrat will do alright but everytime someone makes a profit on fraud SOMEONE else always loses. Always. Conveniently that someone is often nameless and faceless so Wall St can sleep easy pretending that no damage was done. Or it wasn’t their fault that the Chinese bureaucrat was so gullible about the real quality of the AAA securities.
Twofish: (There are some pretty serious issues with the people that were hoodwinked into taking out mortgages that were awful for them in the US, however.)
There you go. I am glad you are willing to acknowledge there were some abuses even though you seem unwilling to acknowledge the pervasiveness of it.
Quite elegant and cogent twofish.
I think that the losses China suffers from a slow appreciation and thus from a support of the US and the USD are and will be well compensated by Chinese GDP growth. And that is what matters the most for them. My guess is that China will continue the 5%/year appreciation (maybe a bit more later) for many years to come.
Guest: But it IS a bad thing. You seem to think Wall St pretty much works like it is supposed to and for the most part those who make money on the Street earns it. But is that really the case?
No it isn’t. In Wall Street as with a lot of life there is a lot of randomness involved, and some people just get lucky or unlucky, as whatever the case may be. I got really lucky in a lot of different ways.
Guest: Just to give one example you think Wall St (and I use “Wall St” to mean the financial sector generally) only takes a “tiny” fraction of the amounts it handles. Define “tiny”.
Assets under management for a typical financial holding company is $1 trillion. CEO of said company typically makes about $50 million/year. $50million/$1 trillion is a small number. As far as the total amount used up, you can look at the numbers like the typical fees for a open fund which run in the 1%/year range. One percent/year of $10 billion, which is a the size of a large mutual fund, gives you $100 million/year to split up among people.
The Chinese market is probably eventually going to have $10 trillion or so of wealth moving around. Let’s take 1% of that, and you have truly stunning numbers.
Guest: The savings that he blew away on some toxic CDO was created out of the blood and sweat of some underpaid men, women and yes even children in China.
And the loss isn’t going to be absorbed by them. Peasant had 1000 yuan in his checking account yesterday. That 1000 yuan is still there. The loss is going to be absorbed through the banks equity, and that is going to pull the price of the BOC stock down. So the people who are going to end up absorbing this particular loss are going to be people who gambled on BOC stock.
Guest: The bureaucrat will do alright but everytime someone makes a profit on fraud SOMEONE else always loses.
And if you trace through “who loses” in this particular case, it’s no one I have much concern about. BOC still can pay the money it owes to widows and orphans. Now if BOC loses $100 billion, then we have a very, very different situation, and the whole point of risk management is to make sure that bank loses $1 billion and not $100 billion.
Also, I don’t see the “fraud” in this case. If you look at any credit rating, you see this huge page of fine print that says that if you lose money from taking our advice, it’s your own damn fault. I don’t expect people on the street to read the fine print, but if you are a banker investing US$10 billion, you presumably have lawyers that go through all that detail, and you are a damn fool that shouldn’t be sitting in the chair if you can’t read fine print, saying in about fifty different ways “we aren’t responsible if you follow our advice and something goes wrong.”
Guest: Conveniently that someone is often nameless and faceless so Wall St can sleep easy pretending that no damage was done.
Damage was done, but it was done to people that could absorb it. Bank of China can take a loss of US$1 billion and it really doesn’t matter to anyone. The people who end up eating the loss are BOC shareholders, and they should have known the risks when they bought the stock.
By contrast, for hard-working peasant to lose the US$100 he has in his Bank of China checking account, would be a massive life-altering disaster to him. But that money is still there for him.
The whole point of finance is to move risk and loss from people who can’t afford it, to people who can. There are people in the world that can lose $100 million and not blink. There are institutions that can lose $100 billion and it wouldn’t matter. There are also people in the world for whom losing $1 would be a disaster.
Guest: Or it wasn’t their fault that the Chinese bureaucrat was so gullible about the real quality of the AAA securities.
The bureaucrat has a nice office and a high salary. He gets paid to worry about things like that. If he really didn’t understand what was going on, he should not have signed on the dotted line. I’m sure that if the bureaucrat thought that he could put one over on the derivatives salesman, he would.
Guest: There you go. I am glad you are willing to acknowledge there were some abuses even though you seem unwilling to acknowledge the pervasiveness of it.
The subprime mortgage thing was a total mess. People that lost their houses because they got hood-winked because of ARM’s, I feel sorry for. Hedge fund managers and investment banks that are now losing hundred of billions because of the mess, I don’t.
But here is the thing. You look at “who loses” and it turns out that the people who take it on in the chin are the investment banks who can afford it. You’ve probably have money in a bank. Go take your ATM card and check your account balance. The money is still there.
To have a system in which you can have this massive $200 billion loss and still not affect the $1000 you have in your checking account, that’s pretty damn amazing. It’s like having a blade of grass still standing right next to a nuclear explosion.
Twofish: No it isn’t. In Wall Street as with a lot of life there is a lot of randomness involved, and some people just get lucky or unlucky, as whatever the case may be. I got really lucky in a lot of different ways.
It is not that simple. Randomness I can live with. This is a rigged game. Nothing random about it. Good for you if you got lucky, there are many others who got lucky who deserve it far less.
Twofish: Assets under management for a typical financial holding company is $1 trillion. CEO of said company typically makes about $50 million/year. $50million/$1 trillion is a small number. As far as the total amount used up, you can look at the numbers like the typical fees for a open fund which run in the 1%/year range.
I have to call BS on this. What company has $1 Trillion under management?
Twofish: Peasant had 1000 yuan in his checking account yesterday. That 1000 yuan is still there. The loss is going to be absorbed through the banks equity, and that is going to pull the price of the BOC stock down. So the people who are going to end up absorbing this particular loss are going to be people who gambled on BOC stock.
And who are these people? It is magic isn’t it? Tha PBoC loses billions on its ill-advised investments in CDOs and MBSes but the peasant 1000 yuan is still there. Or is it? The peasant probably believed his politicians when they promised him he’d have free health care or pensions paid out of his savings that were retained by the government in addition to the paltry 1000 yuan in his checking account. How is he going to feel when his daughter falls ill and he goes to the hospital and finds they can’t treat her because, well, they don’t have enough money because of the mortgage crash?
Twofish: By contrast, for hard-working peasant to lose the US$100 he has in his Bank of China checking account, would be a massive life-altering disaster to him. But that money is still there for him. The whole point of finance is to move risk and loss from people who can’t afford it, to people who can. There are people in the world that can lose $100 million and not blink.
At last we get to the core of it. The whole point of the financial system is to keep the vast majority of the world on a $100.00 checking account balance while all the wealth they toil to create is appropriated by men who can lose $100M and not blink. Wall St will make it happen while only taking a “tiny” fraction as fee. Can anyone with an ounce of intelligence fail to be utterly disgusted by this?
Sad to say, Chinese are on a bubbly path. There’s too much problems to handle.
Bubbly Stocks Markets, Bubbly Housing Markets, Skyrocketing Commodities Costs, Rising Cost of Living and many other common economic issues.
Not to forget Longer Term problems like environmental degradation, gender imbalances (one child policies), ageing population (like in any developing world), political issues (Taiwan, Political succession,…)
Even if we were to consider the immediate shorter term problems, I really doubt they have the means to totally avoid any breakdown in the dynamics of their enclosed economy.
I saw on TV, the Chinese housewifes were practically jousting each other in the supermarts for supplies!
re: “I saw on TV”
with all the focus on the rating agencies, if journalists and economists may at some point be held responsible for the impact of their own rhetoric. whoever it was that coined the slang that is being used to describe u.s. financial products and tabloid style commentary about foreigner threats, the bigger question is why it was so quickly adopted by such a broad community of commentators - why supposedly intelligent, prestigious professors, economists, fund managers and journalists would want to go on record incorporating these expressions into their own blather, still call it analysis and not be taken to task for the broader consequences of their own trash…
Norther Rock is busted in UK. Are you coming to the cash maching to collect the left overs ?
“…All told, the doom-mongers’ script may play out in reverse. Instead of a financial crisis prompting a dollar crash, it may accelerate the unwinding of the imbalances that had the worrywarts so unnerved in the first place…”
http://economist.com/finance/displaystory.cfm?story_id=9804272
“…French President Nicolas Sarkozy wants the European Central Bank to play a more active role intervening in monetary policy to help keep French and European exports competitive. There is also growing concern in Germany… that the powerful euro could upset European economic recovery before it really gets on its feet.” http://euronews.net/index.php?page=eco&article=442623&lng=1
re: ‘not working’ and “How is he going to feel when his daughter falls ill and he goes to the hospital…”?
he’d better hope he doesn’t have to. given the lack of any type of reliable healthcare reporting from China, no reason to believe the situation is any better there:
“Various studies… estimate that there is a one in 300 chance of a hospital patient dying as a result of medical error. One in 10 is estimated to suffer harm, of whom a third suffer serious harm, while studies suggest that 600 errors are made a day in primary care with more than one in 10 prescriptions containing errors…” http://www.ft.com/cms/s/0/90f7172e-d03e-11db-94cb-000b5df10621.html
Brad is correct QDII. so far it has been a bit of a flop
but it was because the bank funds could only hold 50% equities
China FM love upside
downside does not matter
it is all or nothing - just like vegas
One issue i find surprising is the lack of volitity in the A share market given that over 80% is retail?
It is too good to be true!!!
I am aware of companies that are running loss making operations
business finance come from their investment in the a share market
Twofish,
How convenient it is to say that it’s tough luck for the US pension fund or foreign bank that purchased a toxic waste CDO that was marketed as an AAA bond. The Bank of China purchased $10 billion of what was rated as AA bonds by US bond agencies and what they received was toxic waste. It is entirely immaterial that the Bank of China is able to absorb the multi-billion dollar losses on its AA rated subprime bonds marketed by Wall Street. Without one iota of honesty by US Investment banks and corporations that knowingly defraud the public, the United States is destined to become a Banana republic.
“My point is that without money and credit growth, the financial system will cease to exist. It will no longer function. The five big domestic investment banks (GS, MER, MS, BSC and LEH) have more than $4 trillion of assets up against a paultry $100 billion in tangible book value. GS alone has tripled the size of its balance sheet in the last five years which means that its assets are probably of very low quality”
The best story of investment banking is yet to come, banks with no natural deposit base,shrinking assets value,high gearing ratios (25) will have no choice but to be consolidated with retail banks.
Guest: It is not that simple. Randomness I can live with. This is a rigged game.
To an extent it is rigged. The trick is to figure out how to change the rules of the game so that good stuff happens. A lot of it involves trying to figure out what people’s interests are, and how to align them to serve social justice ends.
Guest: I have to call BS on this. What company has $1 Trillion under management?
All of the major banks do. See http://en.wikipedia.org/wiki/Banking
The other thing to note is how little banks make in fraction to the assets they have under management. Citigroup has assets of $1.4 trillion dollars, yet its revenues are “only” $22 billion/year. Incredibly efficient.
Guest: And who are these people? It is magic isn’t it? Tha PBoC loses billions on its ill-advised investments in CDOs and MBSes but the peasant 1000 yuan is still there.
The Bank of China and the People’s Bank of China are totally different entities. The first is a commercial bank, the second is the government central bank. The PBC had no exposure to subprimes.
Guest: Or is it? The peasant probably believed his politicians when they promised him he’d have free health care or pensions paid out of his savings that were retained by the government in addition to the paltry 1000 yuan in his checking account.
The peasant has enough common sense to not trust politicians, and one good thing about China is that the politicians live in constant fear about what that peasant and a few million of his friends can do.
Health care in China is a mess, but the money comes out of a state fund that gets funded via insurance premiums with a government subsidy that goes to the poor. Unlike urban industrial workers, peasants don’t get pensions, and the reason that peasant is saving in the bank is partly so they can retire eventually.
Guest: How is he going to feel when his daughter falls ill and he goes to the hospital and finds they can’t treat her because, well, they don’t have enough money because of the mortgage crash?
Right that money that the peasant has in the bank is used to cover medical bills which is why it is desperately important that the peasant can get access to cash in case of an emergency. It’s a horrible unfair system, but right now the government is rolling out the “New Cooperative Medical System” in which funds are paid out of county level from insurance premiums and central government taxes. Nothing to do with subprimes.
In any case, the government wants to keep the peasant not angry. As long as the peasant thinks that his money is safe, he will work hard, and not have time to do anything politically active. If his checking account disappears, he gets mad, and then with his few million friends will be out to topple the government.
Guest: At last we get to the core of it. The whole point of the financial system is to keep the vast majority of the world on a $100.00 checking account balance while all the wealth they toil to create is appropriated by men who can lose $100M and not blink.
That’s not the business model that any of the big financial companies have in mind. Again. Look at the numbers. The big banks manage trillions so that they can take away tens of billions. A billion middle class Chinese plus a billion middle class Indians generates an extraordinary amount of wealth that you can tap into without anyone caring.
Wall Street wants lots of middle class Chinese folks because you make a lot more money from lots of middle class people than you do from a few rich folks. The Chinese government wants lots of middle class Chinese because giving people the idea that they will get somewhere if they work hard, uses up their energy so that they don’t think too much about overthrowing the government. People with mortgages and stable jobs fight to defend the system rather than overthrow it.
Guest: Can anyone with an ounce of intelligence fail to be utterly disgusted by this?
Part of the game plan of Wall Street is to buy out anyone that might challenge it. I’ve got choices, and if I thought that what I was doing was making the world worse, I could leave and I would leave, but the last thing the powers that be want are smart motivated people who are fed up and want to overthrow the system. So let’s deal.
Now if you have a better plan, let’s hear it. However, one thing that I have little patience for are people sitting around coffeehouses talking about revolutions without thinking about the damage *they* can cause.
I have even less patience with people who can’t do basic arithmetic.
I’m not ideologically opposed to taking all of the money of the rich and giving it to the poor. The problem is that the numbers just don’t work. If you shoot all the rich people and divide up their wealth, the amount of extra money that each poor people gets is tiny.
The rich Hong Kong tycoon who likes fast cars and fast women, and likes to blow huge amounts of money at Vegas. Instead of trying to work against him, wouldn’t it be nice if we can use his wealth and appetite for risk to perform something socially useful.
So you sit down in front of Mr Big, and make your pitch. I got some folks that want to buy a house but are scared of interest rate changes. I have some other folks who run a factory who want coal at stable prices. I have some other folks that don’t want to be wiped out when the next hurricane hits Louisiana. I have some other folks that are starting this high risk business and need some cash to get going. Since you are the betting type and you got money to burn, instead of making your next trip to Vegas, why don’t you put some bets on energy prices or hurricanes or interest rates or private equity. My odds are a lot better than Vegas.
Twofish stated: “Wall Street wants lots of middle class Chinese folks because you make a lot more money from lots of middle class people than you do from a few rich folks.”
Twofish, it appears that Wall Street does not want a lot more middle class US Citizens (let alone Chinese),because, from the accounting/auditing scams that brought us the our last serious stockmarket crash, to the CDO/ClO/SIV light financial engineering scams that are presently destablizing America, the result is the same, middle class Americans, with their pension, job and house losses, are deconstructing. Alan Blinder stated that only 3.4% of US wage earners saw their wages rise from the year 2000 to 2005. America’s richest 1%, on the other hand, have grown dispropertionately wealthier.
Twofish, you like to call DC on his defense of China, but you are a blatent defender of a corrupt, rigged, caveat emptor Wall Street and the robber barons who grossly profit from it.
If Wall Street investment banks in cahoots with the US bond rating agencies had not slapped AAA and AA ratings on the subprime toxic waste, it never could have been sold to most of the foreign buyers. Imagine yourself as German, French, Australian, or Chinese banker who finds out that they cannot even get a quote on an AAA rated subprime toxic waste debt instrument. It’s not just that the AAA paper went down in value. The Bank of China cannot not even obtain a quote on the AA rated subprime toxic waste that they purchased.
The US Investment Banks especially Goldman Sachs should be placed on probation, or, better yet, barred from the Banking business permanently. But don’t count on any regulation or discipline happening in Washington, with former Goldman CEO Hank Paulson the biggest purveyer of the AAA rated subprime toxic waste to US pension funds, state governments, and foreign investors.
2fish speaks plain english and presents an informed view. DC does nothing but rant, slander and pander.
to black swan: The growing divide between rich and poor in the United States is a very serious issue that needs to be addressed, but putting all of the blame on Wall Street is misplaced. There are deep issues about globalization, educational opportunities, health care, and that need to be addressed. Thinking about shooting the bankers and lawyers might make people feel better, but it really doesn’t help the situation. Taxing the rich to fund education and health care would help a lot, but in order for that to work, you need rich people to tax.
Interestingly, Wall Street tends to vote Democrat, and New York City has some of the highest tax rates in the nation, which go to fund things like parks, police, public transit, a massive school system etc. etc.
black swan: Twofish, you like to call DC on his defense of China, but you are a blatent defender of a corrupt, rigged, caveat emptor Wall Street and the robber barons who grossly profit from it.
Thank you. Someone has to do it. I don’t think “robber baron” and “grossly profit” is applicable here. Wall Street is a tiny mosquito drinking blood out of a massive elephant. Look at the numbers for a typical bank. $1 trillion in assets. $30 billion in profit.
DC: All bond ratings have this long disclaimer….
http://www.kasnicrating.com/kasnic/pages/disclaimer.php
Now if you want someone to guarantee a CDO, you can find someone who will do it for a price.
Also, Wall Street banks are global institutions. People on Wall Street are constantly on the phone with people in London, Tokyo, Hong Kong, and Singapore. NYC-based banks are full of Germans, French, Austrialians, and Chinese which greatly limits the ability for the US government to use IB’s as an instrument of US foreign policy. The employees and shareholders of your typical investment bank couldn’t care less if the CEO was American, German, Chinese, or Martian as long as they make profitable decisions.
DC: The Bank of China cannot not even obtain a quote on the AA rated subprime toxic waste that they purchased.
Banking and finance is hard work, and this is one reason why. You have to worry about the million things that can go wrong.
DC: The US Investment Banks especially Goldman Sachs should be placed on probation, or, better yet, barred from the Banking business permanently.
IB’s that invested heavily in selling subprimes are being forced to cough up money, because some of the CDO’s they sold *did* come with guarantees. Hedge funds and mortgage originators have gone out of business. The broader US economy is still in OK shape.
Twofish: The other thing to note is how little banks make in fraction to the assets they have under management. Citigroup has assets of $1.4 trillion dollars, yet its revenues are “only” $22 billion/year. Incredibly efficient.
That’s a meaningless number. A banks assets may be huge but there are always offsetting liabilities. According to Google Finance, Citi has Assets of $1.47T but liabilities of $1.39T. It is nothing more than an accounting entry. the $1.4T number has no economic meaning whatsoever.
Much more relevant is the cashflow which according to Google Finance was around $20B annually, incomes of a similar amount and margins of over 20%. In other words, Citi essentially appropriates more than 20% of all the money it touches. Very efficient indeed.
“At the end of the day, it’s about ending world poverty so that this guy in a funny hat and beard who is now somewhere in the Pakistan / Afghan border, doesn’t win. About six years ago, he attacked New York because he (correctly) figured out that Wall Street is his biggest enemy to that keeps him from imposing his vision on the world.”
twofish - bernanke has a beard, too. i think you are making a childish ad hominem attack. and do you really think that ‘wall street’ is dedicated to ending world poverty ? then we are in an even worse hole than i realised. as marie antoinette might have said of the peasants -
‘no bread ? let them eat derivatives.’
Gillis, when the they start stormning the Bastille, 2fish better be swimming out to sea.
gillies: twofish - bernanke has a beard, too. i think you are making a childish ad hominem attack. and do you really think that ‘wall street’ is dedicated to ending world poverty ? then we are in an even worse hole than i realised.
To be fair if I was working on Wall St I’d want to believe that too. Everyone wants to think that they are doing worthwhile work and they are benefiting the world etc.
Guest: That’s a meaningless number. A banks assets may be huge but there are always offsetting liabilities. According to Google Finance, Citi has Assets of $1.47T but liabilities of $1.39T. It is nothing more than an accounting entry. the $1.4T number has no economic meaning whatsoever.
Yes it does. You deposit $1000 at 5% interest into Citicorp in a savings account. After one year look at your bank account and it says $1050. This is counted as a liability to Citicorp. Now what happens is that Citicorp is likely to find some way of making 6% from your $1000. That extra $10 then goes to Citicorp. Of that $10, about $8 will be used to pay for things like the tellers, the cash machines, and the CEO. The remaining $2 goes to the shareholders.
If it were the case that Citi took 20% of all the money it touches, then if you put in $5000 into your checking account, you’d expect to lose $1000 of that by the end of the year. The thing about banking is that when it works, you don’t think about it. You direct deposit the money into your account, voila, it’s there when you try to pull it out. Magic.
Wall Street is dedicated to making money, and you make money by helping other people make money. Getting two billion people in Asia out of poverty, that’s a lot of money to be made.
I don’t have to work here. There are hundreds of things that I could be doing other than working where I am. The nicest thing about working on Wall Street is that people *think* about what they are doing and the ramifications of what is happening around them.
Again, if you have any better ideas on how to end world poverty or anything more productive you think I could be doing with my time, I’d like to hear them……
Twofish: If it were the case that Citi took 20% of all the money it touches, then if you put in $5000 into your checking account, you’d expect to lose $1000 of that by the end of the year. The thing about banking is that when it works, you don’t think about it. You direct deposit the money into your account, voila, it’s there when you try to pull it out. Magic.
Citi’s own financial statements say its margins are 20%. We shouldn’t forget that Citigroup is more than a bank. It is a financial conglomerate including mortgages, investment banking, proprietary trading etc (isn’t Salomon part of Citi?)
Assets are misleading. A banks assets and liabilities can be huge but that doesn’t represent wealth that is actively managed by the bank in any way, shape or form. We could write each other checks for $1B which will make our assets and liabilities really big. So what? I’d like to see Citi’s assets broken up in categories. How much of it is related to notional values of derivatives contracts? Tellingly: does Citi pay taxes based on the size of its Asset column? I didn’t think so.
Cashflow is a much better indicator of just how much REAL money moves around. Or you could use income. As a fraction of its cashflow or income Citi does make an obscene amount of profits. 20% according to their own numbers. If you dispute that number you should call the SEC.
Twofish: Again, if you have any better ideas on how to end world poverty or anything more productive you think I could be doing with my time, I’d like to hear them……
I have to confess I don’t have any magic solutions for big problems such as world poverty. I do have some ideas to make things a little better - by unrigging the games that financiers play.
1) The biggest source of financial fraud is derivatives. Everyone says how they have wonderful uses for hedging economic risk. Which is true. The problem is the vast majority of derivatives are written not for hedging economic risk but for shady reasons like ratings-arbitrage (toxic AAA CDOs), tax-arbitrage, obfuscating balance sheets (like Enron!) and simply leveraged gambling (Bear Stearns hedge funds).
Easy solution: voluntary regulation. Any derivative contract along with the formulas for valuation have to be approved by a regulator. If some hedge funds prefer to stay unregulated fine. The US court system will simply decline to enforce any financial contracts such entities may enter into.
2) Finance is close to a zero-sum game so financial profits provide little benefit to the economy compared to say an industrial venture. Tax financial income at substantially higher rates.
3) Rating companies are held accountable for the accuracy of their ratings. The idea is to discourage them from providing any ratings at all to illiquid instruments where the uncertainty is large and the potential for abuse is also large.
4) A Tobin tax. It has been claimed that such a tax would reduce liquidity. But it can easily be indexed to the available liquidity so tax is high when the trading is very busy but drops to zero under illiquid conditions.
All of these would of course have some disadvantages. Fewer poor borrowers may get home loans, companies have to pay higher interest on junk bonds etc. But on the whole it’d be price worth paying to address the financial abuses. At least we can expect to have fewer market crises.
As far as bank assets and liabilities go. The trillion dollars that a major bank manages is real money. When you go to a bank and deposit $10, it is recorded on the balance sheet as an asset because the bank now has your $10 and also as a liability, because the bank owes you $10. That $10 you have on deposit is part of that $1 trillion dollar asset base.
Sure you and I can exchange $1 billion checks, but I can’t sell that check to someone else. Citi doesn’t pay taxes on assets because financial assets are not taxed. Income is taxed. You can google for the annual report but most of Citigroup’s liabilities consists of money that it owes depositors. (i.e. it’s your money).
As far as restricting derivatives. The problem here is that practically every financial transaction in the United States ultimately involves some derivative somewhere changing hands. If you get a loan on a house or a car, if you have a credit card, if you have a small business loan, if you have insurance, if you run a factory. Follow the money, and somewhere there will be a derivative security that changes hands in the background. (I can go through each of those scenarios and tell you exactly what type of derivative changes hands.) When something goes wrong, you see all of these derivatives in the background and people associate derivatives something something bad. However, what people don’t realize that derivative securities are so pervasive that they are going to be there when something bad doesn’t happen.
Regulation is good thing, but you need to make sure that you aren’t overwhelmed by minute details and miss the big picture. The big picture is that it would be very, very bad if someone went to their checking account that they have at a bank, and the money just was not there.
To prevent that from happening is the mandate of the Federal Reserve, and banks are required to make constantly be reporting to the Fed about their risk positions, and the models that banks use for risk analysis do have to be approved by the Fed. It’s really geeky, cool work since you have massive clusters of computers running risk scenarios being programmed by dozens of physics, math and computer science Ph.D.’s, all trying to make sure that when you try to take out money from your bank account….. It’s there…..
bsetser “the larger its ultimate losses”
It all depends on your time horizon. For the western daily or at most quarterly but in the decades that will be needed for China to become as wealthy as the west it’s unlikely. Year on year CNY is up more than 5% against USD, this trend means 27% for five years, 62% for 10 years.
So unless you think the USA will become a poor country and/or that the dollar zone will enter hyperinflation, there is no long term risks.
Twofish, 22 billions divided by 1.4 trillion is 1.57%. At this level it’s just robbery! If you take FFR (french state managed pension fund) their yearly cost is 68 millions euros for 33.4 billions assets under management, that’s 0.2% so 7 times less than Citi…
if that may be charged after a citi takes its cut…
Twofish: The big picture is that it would be very, very bad if someone went to their checking account that they have at a bank, and the money just was not there.
Well you are setting yourself a ridiculously low bar there. This is like the AMA telling its doctors it’d be a very, very bad thing if the patient dies. But as long as the patient is not dead don’t worry you can screw up as much as you want because he is alive. Would you trust a doctor who has that attitude? Why should you trust a banker who thinks like that?
Banks have FDIC insurance which is backed by the US govt which is backed by the Fed’s printing presses so of course no one checking balance can ever disappear. Does this mean that the banks can do anything and it will be just ok as long as the checking accounts are available? What if some company’s pension fund blows up? Would that be ok as long as the pensioner’s checking account still has their $100.00 completely intact?
The Fed’s oversights are minor and still leaves plenty of room for abuse. It is no use pretending everything is fine just because the checking accounts didn’t blow up.
re: “What if some company’s pension fund blows up?”
or is cancelled: “…This week Sarkozy is expected to announce that he will end the generous special retirement packages … Last week he called the special pension deals, which cost the French taxpayer £3bn a year, ‘a disgrace’…” http://observer.guardian.co.uk/world/story/0,,2170157,00.html
“But as long as the patient is not dead don’t worry you can screw up as much as you want because he is alive. Would you trust a doctor who has that attitude?”
but the patients do die - medical mistakes are one of the leading causes of death - so the question may be how many doctors (professionals) don’t have that attitude…
“The heated debate surrounding the medical malpractice crisis has left many doctors, insurers, attorneys, and patient advocates looking for “middle ground” solutions. Not satisfied with the oversimplified solutions of “caps,” insurance reform, and stricter doctor discipline, people of good faith from all sides in the debate are looking for real solutions to the medical liability crisis. The Sorry Works! Coalition (www.sorryworks.net), launched in February 2005, is comprised of doctors, insurers, lawyers, and patient advocates… We believe that apologies for medical errors, and, when necessary, appropriate upfront compensation reduce patient and families’ anger, reducing medical malpractice lawsuits and associated defense expenses… The greatest hurdles of all are medical culture and physician behavior. John Banja, bioethics professor notes in Medical Errors and Medical Narcissism…: “Expressions of professional narcissism, hyperdefensiveness, and blame shifting are coping mechanisms that help healthcare professionals manage the dissonance between their perfectionist aspirations and the reality of their imperfect selves and environments…” http://www.psqh.com/novdec05/what-if.html
and of course, the patients that are sickened by the treatment, but don’t die, are still in need of more (expensive) treatment at the hands of someone…
my only point being that if you are going to talk about trust and asset management/allocation abuse issues in the system, you might want to go beyond a narrow range of targets. I find it interesting that you seem to be using the medical profession as a (higher?) standard by which to judge the banks…
Guest: I find it interesting that you seem to be using the medical profession as a (higher?) standard by which to judge the banks…
The point is you will get absurd results if you set ridiculously low bars for any profession. Twofish’s statement “it would be very very bad if someone lost the money in their checking account. But fortunately the good folks at the banks are working very hard to make sure that doesn’t happen so the banking system is just fine even though homeowners and pension funds are going bankrupt” is a fallacy.
Just like the following would be fallacies
“it would be very, very bad if the patient lost his/her life but fortunately that didn’t happen so everything’s fine even though someone’s leg got amputated by mistake”
or
“it would be very, very bad if eighth graders don’t know how to read and write but fortunately our school masters are working very hard to make sure that doesn’t happen so everything’s fine even though the students don’t know what the capital of the country is”
and so on.
if i may suggest a more pessimistic view that there are strong economic incentives to produce mistakes. the medical mistake creating a need for another research grant and drug to treat the new problem; the inadequately trained student creating a need for more education services; the newly pensionless, homeless person, who didn’t have all that much in their savings account because rates were so low, creating a captive client for new government and financial products and services; the deadly pig virus, which is feeding food price in china inflation and possibly providing proof of some of the opportunistic illness that result from chronic pollution problems, creating a vast profitable, prestigious new market for vaccines:
“…Among the possible conditions for the sample sharing that are being discussed: that patents and royalties from the development of vaccines and treatments remain the property of China. “There has been a feeling that in the past, some Chinese scientists have not been given recognition for their contributions,” …Officials at the Ministry of Agriculture declined to answer questions by phone about the pig deaths and did not respond to questions faxed to them. The tissue samples that China has obtained are the key to any scientific research on what’s killing the pigs in China. Without them, it’s impossible to verify the type of illness, much less develop a cure for it. As with all viruses, the more the blue ear pig disease spreads, the more money there is to be made in a vaccine…” http://www.washingtonpost.com/wp-dyn/content/article/2007/09/15/AR2007091501647_2.html