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Sovereign wealth funds

by Brad Setser
September 23, 2007

michael pettis

One of my tricks when I want to look smart on the topic of global financial flows and monetary conditions is to check out the latest entries in Brad’s blog, which is the only blog I read nearly every day.  Now that I am guest blogger, of course, this trick isn’t going to work nearly as well, although some of the comments from some of Brad’s regular readers should help somewhat. My background is in emerging markets, which until 2002 generally meant Latin America but since then, when I moved to Beijing, has largely meant China.  I will try as much as possible to discuss global conditions, like Brad does, but I suspect I will be spending far more time on China and emerging markets in general than he normally does. 

So with that caveat, let me post my first blog on – what else? – China, and more specifically what we know or think we know about the soon-to-be-established but already operational sovereign wealth fund.  I will use as my crib sheet a very interesting report prepared by Xinxin Li, chief China analyst for the G7 Group, a New-York-based consulting and research firm. I have been spending a lot of time thinking about the impact of these funds. 

In early August, just as the sub-prime crisis was really getting going, I wrote an op ed piece for the Wall Street Journal that argued that, in spite of the problems we were facing, not only was this not going to be the end of the world – I expected spreads to be back by October – but that the crazy party we have been living through would go on at least a few years longer.  A lot of my friends on Wall Street (I am a former emerging markets bond trader) wrote me very patient emails explaining that I had finally lost all my market sense – it was obvious that this time around the crisis was so severe that it was going to derail the whole liquidity boom.  This, according to them, really was going to be the big one.  I still disagree. An important part of the reason for my believing this has to do with the reserve management strategies of China, Japan, the OPEC countries, and other, mostly Asian, central banks. 

It is a basic assumption on my part that globalization cycles, of which by my count there have been six in the past two hundred years, are driven largely by new developments or structural changes in the financial system that cause a significant increase in global liquidity and a concomitant increase in risk appetite.   Because of rising risk appetite this newly-abundant capital flows into a variety of risky countries or ventures – financing canals in the 1820s, railroads in the 1860, long-distance communication media in the 1920, the internet in the 1990s – and sets off the growth in international trade, capital flows, technological development (and, for some reason, the rebirth of liberal economic theory) that we associate with globalization. 

I write about this history extensively in my book, The Volatility Machine, which Brad was nice enough to plug, and in articles in various journals. These liquidity cycles were never smooth sailing but were often interrupted by sometimes shockingly severe crises in the form of temporary liquidity panics which, after scaring the hell out of everyone, eventually reverted to benign conditions.  Some well-known examples might be the Overend Gurney Crisis in 1866, the Panic of 1907, or the 1976 Peso Crisis and, I am willing to bet, the sub-prime mortgage crisis of 2007.  Each of these crises was severe and frightening, and each resulted in significant subsequent changes in regulations and banks, but each also ended with minimal damage to the economy and a quick reversion of the earlier optimal liquidity conditions.  The jury is still out, of course, but I expect the same will occur over the next few weeks and months as the impact of the sub-prime mortgage crisis fades away. 
These liquidity cycles do eventually end, of course.  Typically when they do end they end badly.  The 1873-80 depression, the Great Depression, and the Latin American Lost Decade are all examples of a real close to the liquidity cycle, but these real endings are very different from the liquidity panics that interrupt them.
 

We are pretty certainly living through a major liquidity expansion cycle, and in my opinion there have been two important causes of the current expansion.  The first was the beginning of the massive securitization of illiquid assets, especially of mortgages, in the 1980s, which had the effect of turning a huge amount of illiquid assets into extremely liquid and widely-traded securities.  I believe that Robert Mundell would argue that increasing the “money-ness” of an asset is analogous to increasing the money supply, and this massive securitization process had that very impact.   More important than securitization, especially in recent years, has been the Asian recycling of the massive and growing US trade deficit.  To me this recycling process is a machine that converts a big chunk of US consumer spending into Asian savings, leading to what Bernanke has called the global savings glut, and may have had some similarities with the petro-dollar recycling that fueled the LDC lending boom of the 1970s. 

If you agree with this model of globalization, the trick to projecting financial markets is then to predict the evolution of the US trade deficit and to follow the way in which it is being recycled.  I am not smart enough to tell you what is going to happen to the US trade deficit, but whatever happens it is likely to change fairly slowly.  Unlike most commentators, I think, I do not believe the US trade deficit is very serious problem for the US and I do think that there are very strong structural reasons that will cause it to reverse significantly over the next few decades, so as far as I know this could continue for a few more years. 

I can however make some higher quality guesses about the recycling process, and here I think China, because it has the largest hoard of reserves, is in the front line of the global change in central bank reserve investment strategy. As we all know, China is accumulating reserves at a furious pace, and I would argue that the whole process has gone so far out of control that there is nothing the financial authorities can do to stop it.  It will take a fairly nasty “adjustment” of some sort or other to reverse conditions, and until we do get this shock, the reserve accumulation process will continue and even speed up.  It has become pretty clear, however, that whatever the appropriate amount China needs to keep in liquid, safe, and therefore low-yielding assets, it is far less than what they actually have at China’s central bank, the People’s Bank of China (PBoC).  That has prompted the authorities to move part of their reserves into some kind of sovereign wealth fund where it can be more actively managed (and to manage more actively, according to rumors, the portion that has remained at the PBoC).  Active management, of course, is another way of saying that it will be deployed to buy a much wider range of riskier assets. 

As China and the rest of the high-reserve countries increasingly recycle the US trade deficit into riskier assets, the sheer size of funds under management will appreciably drive global risk appetite up.  This, as I wrote in my WSJ piece, will keep this crazy party (which has already gone on long enough) going for at least a few more years.  This is also why I think it is extremely important to keep an eye on what these sovereign wealth funds are doing.  

Because this posting is already long enough, tomorrow I will discuss the Chinese SWF and what Xinxin Li and others are suggesting about its evolution. 

39 Comments

  • Posted by Guest

    Welcome Michael!

    China’s timing is fortunate. Recent events have raised awareness of where risks lie, and reduced the price of risky assets.

  • Posted by kaan

    micheal,
    I agree that the chinese will do their best to continue this vendor financing regime. The problem is the short term financing of the long term illiquid structured products, whose collateral will keep deterioate for a long time.
    I think chinese SWF fund will focus on resource and technology.Yes USD recycling from China is intact but money markets may not benefit and rampant credit creation mechanism may go kaput.

  • Posted by RebelEconomist

    Sorry, that comment was from me…..I am not keen on Guest comments myself!

  • Posted by Michael Pettis

    First of all sorry for posting this in such a messy way. I am still learning the system.

    I think you are right, RE, that the timing is good what with prices having declined, but from my discussions with the bankers who deal with Chinese buyers, the events of this summer have shaken people enough to make them very cautious. My sense is that they will hold off buying until markets recover. Remember that these guys are not traders, and their number one objective, especially after all the criticism they received for putting $3 billion into Blackstone and seeing $600 million of it disappear in weeks, is not to do anything for which they can be criticized.

  • Posted by Macro Man

    Welcome, Michael. If I could be so bold as to suggest a couple of points of interest, I’d be curious to hear your thoughts on both CIC’s likely asset allocation over the next couple of years (should we read much into the appointment of Gao Xiqing, and use the AA of the Social Security Fund as a model?) and the degree to which CIC will siphon away marginal FX reserves away from SAFE.

    On a more superficial level, could you explain why it it still Peking, as opposed to Beijing, University?

    Welcome to the blogosphere!

  • Posted by Michael Pettis

    I will try to address your main questions on tomorrow’s entry, MacroMan, but as for your last question, it seems that the administrators wanted to keep the foreign name that the world know’s best. In China the school is known as Beijing Daxue, but like Peking duck and Peking opera, abroad it has kept the old pronunciation and this is the school’s offical name in English — the email site is PKU.edu and all the marketing material (including t-shirts) lists Peking University, not Beijing University. Only the New York Times calls it the latter.

  • Posted by BigJohn

    Good Day Michael,
    Much has been written in the blogosphere about the possibility of the Chinese to use their accumulation of American dollars as a “weapon” against us in retaliation for trade restrictions or some other malfeasance. Can you comment on the likelihood of them deliberately reducing their holdings of American debt for political reasons? Thank you and I look forward to your writings on Brad’s site.

  • Posted by AF

    Michael, don’t you think the political backlash in China resulting from the 20% / $600 million loss, with more probable loss on the horizon, on the Blackstone IPO will restrain PBOC risk appetite in a very material way?

    Also: I wonder if a very large chunk of the PBOC’s reserves are earmarked for shoring up the Chinese banking system? I see the Chinese stock market boom as a function of savings fleeing a banking system which offers highly negative real interest rates even if it does have tax preferences for saving. (According to PRC statistics, which we all know are cooked, real interest rates on Chinese deposits are approximately -3% — 6.5% inflation, 3.7 percent interest — correct?)

    To whatever extent the Chinese do not invest in dollar-denominated assets, they will have to sell dollars on the FX market if they want to invest in anything. Their remaining dollar reserves would, under that scenario, lose significant value as China drives down the dollar’s value. Chinese investors have already been significantly burned by subprime, and if they see dollar denominated assets as significantly inflated due to subprime problems, why would China gain any return by shifting out of one bubble (Treasurys) and into another (equities and commercial paper)? Why should they believe they’d get any extra return that way?

    I heard from a pretty informed source that in mid July, at least one major Chinese bank was coming under severe pressure from evaporating deposits. Given that the SSE and HSI have only diverged further from worldwide indices since then, wouldn’t that problem have only gotten worse?

    It seems to me that China is dancing on two bubbles regardless of what it does. If the Chinese government puts its foot down and curbs Chinese equities enthusiasm, millions of speculators get screwed. If it does nothing, inflation will spiral to double digits by the Olympics, with apocalyptic deflation/ recession/ unrest necessary to rebalance afterwards.

    Therefore one would expect the Chinese markets to begin “adjusting”/ hemorrhaging 3-9 months prior to the Olympics (since everyone thinks the party will go on until the Olympics are over). That’s right around when all those subprime mortgages will reset, right?

    The Chinese gov’t will be able to bail out banks to some degree just because they have so much cash, but how much? It seems to me that SWFs themselves are functions of drastic trade imbalances, and all their cash will be needed to shore up the home economies (esp banks) once the US consumer completely craps out. Thoughts?

    Thanks, Alex

  • Posted by AF

    Also, this is probably impossible to answer, but what’s your estimate of domestic Chinese inflation? In theory currency controls should result in dramatically higher domestic inflation — this was why Argentina stopped publishing inflation statistics a year or so ago. China seems to prefer the “cook the books route.” Anecdotally, I hear that Chinese inflation has been lowballed for quite some time.

    Smarter people than I predicted that China’s domestic inflation was a lot higher than its stated rate, and that it would manifest itself in localized eruptions in market prices, because localized eruptions can be “written off” by investors as irrelevant.

    So of course the Chinese are blaming the current inflation on a disease that wiped out a bunch of its hogs and ratcheted up beef prices. But Chinese hog purchases were not nearly commensurate with anticipated hog demand. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aX7FNcovuQZ4

  • Posted by Emmanuel

    Michael Pettis: the “global savings glut” hypothesis is difficult to support empirically. As Stephen Roach has noted, global savings as a proportion of global GDP has remained virtually unchanged since 1990. Instead, the pattern of savings has. Some folks have decided to save more (countries running large CA surpluses by definition) while others to save very little (you know who). I have several other quantitative differences with these Cheneynomic “deficits don’t matter” hypotheses like the “global savings glut” but consider this for now:

    There is no glut of global saving. Yes, global saving has risen steadily over the past several decades, but contrary to widespread belief, the rise in recent years has been no faster than the expansion of world GDP. In fact, the overall global saving rate stood at 22.8% of world GDP in 2006 – basically unchanged from the 23.0% reading in 1990. At the same time, there has been an important shift in the mix of global saving – away from the rich countries of the developed world toward the poor countries of the developing world. This development, rather than overall trends in global saving, is likely to remain a critical issue for the world economy and financial markets in the years ahead.

  • Posted by gillies

    the chinese have too much money to deploy, unless they diversify vigorously. do they want to be like the bunker hunts, driving up the market in e g one commodity, ( silver in the case of the hunts), until there is no where for the price to go except all the way down again ?

    do they want to be like saddam hussein, when he switched to selling iraq’s oil for euros, but by his very decision turning the market ? (the euro was steadily declining against the dollar before that.)

    and it is not just the size of their own likely investments. every dealer on the planet will be waiting for the next rumour on what the chinese are going to buy next. surely that will create massive volatility unless they break up their funds into small tranches and diversify ?

  • Posted by gillies

    if there has been a savings glut, then there must equally be an ‘investment in the bond market’ glut on the part of the chinese.

    the lowering of interest rates will make the dollar weaker and investing in dollars less attractive, won’t it ? ben bernanke acts like a good communist, obedient to the needs of the party – but tell me, will the markets not fight back by being willing to pay less for bonds, thus effectively raising interest rates ?

    i do not pretend to understand this. i think capitalism (‘free markets’) always wins. i think bernanke’s helicopter could easily get shot down.

  • Posted by Cassandra

    In the case of Norway, ADIA, KIO, Temasek, perhaps SWF is the correct term.

    But I have my doubts that SWF aptly describes the China’s (and Japan’s should it choose to follow) dollar-hoarding enterprise. For if you think about it accounting terms, a true SWF would be the equivalent of “monetary assets”, “short-term investment and securities” and “long term investments” in the truest sense. These are assets, and deemed bankable by most interpretations when assessing value. For China (and Japan), however, their vendor finance scheme has crossed some undefined, yet tangibly apparent threshold such that their assets are more akin to “accounts receivables”, and extending it further, not yet discounted for crediit or FX risk in the form of either an “allowance for doubtful accounts” or hypothetical liquidation value. At least in the corporate world, factoring is always a possiblility, albeit at a hefty discount, but no such exit is available to China or Japan.

    I therefore sugggest that distinguishing them by calling them VVV’s or” V-Cubed as the acronym for Vendor-finance Value-salvage Vehicles” would add to the clarity of the debate by distinguishing those accumulating reserves inadvertantly (e.g. Oil exporters) from those who’ve accumulated reserves, by design and in such gobs, that an accountant is forced footnote and discount the impact upon realizable value.

  • Posted by jkh

    Regarding the current liquidity expansion cycle, a different history without securitization might have produced more commercial bank asset expansion. This would have required matching liability expansion, with more of the dominant category – money. It’s unlikely total mortgage funding and lending volumes could have increased to the same degree as has been the case with securitization (with mixed results as we know). Perhaps securitization, more than increasing moneyness per se, has enabled broadly increased origination (and funding) of illiquid assets that the banking system would never have had the capacity to monetize.

    Also, you characterize the dominant global capital flows as a US deficit-recycling process, comparing it with earlier petrodollar recycling. I like this view, but didn’t get quite the same impression from reading recent posts on your home blog. There you seemed to infer more causality to US capital inflows as impetus for the current account deficit. Across economic commentary in general, causality seems to be quite malleable in the linkage between CA deficits and capital surpluses. My own preference is the deficit recycling perspective.

    Thanks for undertaking guest blogger duties. A bonus for us has been the opportunity to discover your own excellent blog site.

    P.S.

    - Looks like open season on the global savings glut. Love the smell of deficits in the morning.

  • Posted by adiemuso

    Hi Micheal,

    Like the others, I appreciate your blogging here. I myself have benefited.

    Personally, I think the Chinese are bracing themselves for a big correction in their red hot bubbly economy. Exponential stocks growth, assets appreciation, inflation, environmental issues, population econs issues, political issues( Taiwan, Leadership succession)

    However, the Chinese have definitely improved a lot, be it technology, education, culture, arts, etc… They have definitely learnt the finer art of Banking and Economics.

    This hoarding of FX reserves, the establishment of “SWF” and others, in my view, are part of their modernisation and revamp of their financial policies making. I think it is a good sign.

    I think that this Chinese glut, along with the MiddleEastern, are likely to be recycled into their domestic projects i.e infrastructures,education,environment,etc… Otherwise, these idle excesses are channeled into more strategic assets. Im unwilling to pass any premature prognosis on their Blackstone decision. To me, Blackstone gives them access to areas which previously would have outrightly been politically vetoed.

    And so, the inevitable global major risk/asset repricing might have less than “doomsday” impact on the Chinese holdings. I think much of the responsibilities lie with the Chinese themselves, can they clean up their past baggages before the global environment turns nasty? It is more of an internal issue rather than an external one.

    Make no mistake about it, the Chinese are getting more influential by the day.

  • Posted by adiemuso

    Sorry, I got your name spelled wrongly, it should be Michael.

    My apologies.

  • Posted by Twofish

    AF: I heard from a pretty informed source that in mid July, at least one major Chinese bank was coming under severe pressure from evaporating deposits. Given that the SSE and HSI have only diverged further from worldwide indices since then, wouldn’t that problem have only gotten worse?

    A lot of how bad this news is depends on which bank. It is the Agricultural Bank of China, everyone knows that it is insolvent, a bailout is in the works, so that isn’t big news. Same if it is a rural credit cooperative. If it is one of the joint stock commercial banks, then this is moderately bad news, but not the end of the world. If it is BOC, ICBC, CCB, or the Bank of Communications, then this is really bad.

    The thing about the Chinese banking system is that it is very heterogenous ranging from very well run, very well capitalized banks to those that are being kept on life suppport.

  • Posted by Twofish

    AF: It seems to me that China is dancing on two bubbles regardless of what it does. If the Chinese government puts its foot down and curbs Chinese equities enthusiasm, millions of speculators get screwed.

    But they’ve been screwed before (several times in fact), and it hasn’t been the end of the world. If it is just individuals betting on the stock market, I don’t think there would be much of a problem. What may cause a problem is if businesses are investing in the stock market, which means that a collapse of Shanghai stock prices would have major ripple effects.

  • Posted by RebelEconomist

    Unlike Norway, ADIA, GIC etc, the CIC, and any similar development in Japan, should not be called Sovereign Wealth Funds, because they do not represent sovereign wealth as their assets are matched by domestic currency liabilities. National wealth maybe. This is not just semantics. Abstracting from exchange rate policy, the CIC will essentially be a national hedge fund. I am not sure that it is an appropriate activity for a state.

  • Posted by Guest

    RebelEconomist on 2007-09-24 04:43:45

    Not really. It’s no different in substance than funding any ‘soverign asset’ from government debt or central bank sterlization bonds or central bank monetary base. In all cases, the public is holding a financial asset that is the liability of the government/central bank/SWF/etc.

  • Posted by RebelEconomist

    Guest on 2007-09-24 06:42:18:

    The possibility you missed is that government has “net” wealth from taxation – eg of oil revenues. You could argue that this is matched by a liability in the form of a public equity stake in the state. I guess the point is, what happens if the SWF investments fall short of the funding cost.

  • Posted by Guest

    But the possibility you missed is whether or not the government has net wealth from taxation, the marginal issuance of any form of government liability (debt, CB money, SWF debt, etc) or the existence of any outstanding liabilities versus assets makes absolutely no difference to that net wealth position – i.e. balance sheet transactions per se do not affect net wealth or net equity positions. The issuance of debt per se has no effect on whether a government (alone or consolidated) is running a surplus or deficit. Surplus entities issuing debt merely build up cash or on-lend / on-invest.

  • Posted by RebelEconomist

    I am not saying that issuing liabilities does alter the net wealth position, although if the government has net wealth, then its liabilities are probably minor, and its reason to issue them – eg to serve as money or keep open a domestic risk-free bond market – is hardly relevant to the SWF. My point is two options that a government should consider before a SWF are (1) selling reserves and contracting the public sector balance sheet and (2) matching reserve assets with liabilities that are similar in as many respects as possible (except currency of course).

    My own view for Japan, for example, is that, especially now that the yen is weak, it would be much better to reduce its reserves and pay down government debt rather than start a SWF.

  • Posted by Guest

    If they considered selling reserves to be an option, that would contradict the rationale for an SWF in the first place, which is to diversify reserve investments, given the decision to accumulate reserves. Reserve accumulation policy supercedes reserve investment policy. ‘Hedging’ the non-currency risk to liabilities is a related idea. That constrains any diversification motivation and would argue for China to just keep investing in treasuries for example – that may be a reasonable idea; I have no opinion on it one way or the other.

  • Posted by Michael Pettis

    I responded to several of these comments yesterday, but unfortunately am still enough of a novice on Brad’s blog to have lost them — and a pity too, because it turns out that my responses were incredibly wise and informative. To give an abridged version:

    Big John, I do not believe China can deploy its reserves as retaliation without causing far more damage to its own economy than to the US. If you are interested I discuss this is an earlier entry on my own blog.

    AF, I agree with much of what you say, but I do have one caveat. China cannot use its reserves to shore up the banking system. First, there is the difficulty of converting dollars to RMB – under the current regime the PBoC is the only real buyer of dollars, so it would not be able to sell them without causing the RMB to go through the roof. Perhaps more importantly, as RebelEconomist points out, reserves are not wealth. They are the asset side of a balance sheet against which the PBoC has (appreciating) liabilities. For the PBoC to “help” the banks by giving them money the government’s net indebtedness would rise just as surely as if the MoF borrowed the money to give to the banks. If you are concerned, as I am, that government debt levels are already too high, helping the banks at the expense of the creditworthiness of their guarantor would not be a good thing.

    JKH and Emmanuel, I am not sure that the global savings glut thesis requires a rise in total savings. Basically Bernanke’s argument, as I interpret it, is that excess savings in one part of the system creates through the balance of payments mechanism an excess consumption in another part of the system. If every part of the global system were completely rigid, a rise in savings in one part would result in a global rise in savings. But if at least one part of the system has a highly open and flexible financial system, it will act as the residual that changes its own savings and consumption mix to force the overall system back into balance. In the aggregate total savings and consumption may seem to have changed little, but what has happened is that an imbalance in one part has forced an equivalent but opposite imbalance in the other. Not only does this seem to me an automatic outcome of excess savings, but it also seems to describe reality quite well

  • Posted by RebelEconomist

    Michael:

    I believe that the Chinese government can use its dollar reserves to “help” banks. If the government can invest dollars in a chinese bank which count as capital without being exchanged for renminbi, that bank can run with less of its own capital, which may allow it to be more profitable and repay the government. Perhaps such dollars no longer as reserves but that is hardly a problem for the Chinese. Of course, banks are supposed to hold capital against the risk of loss, so this use of reserves certainly represents a contingent liability for the government. If I recall correctly, the Japanese government did something like this in the 1990s.

  • Posted by Michael Pettis

    You are right, Reb, about using the dollars as part of their capital base. The main point, however, is that if the government wants to give money to the Chinese banks (and to their shareholders too, by the way, which include lots of foreigners), any way they do it will represent a net increase in their own indebtedness, and it doesn’t really matter how big the reserves are.

  • Posted by RebelEconomist

    Michael:

    What is the difference between a dollar investment in Blackstone and a Chinese bank? Both are equity investments which have some market value unless the firm goes bust. So the government have not given anything away – not principal at least, although the return on their capital might be poor, otherwise the private sector would have gladly provided it – and unless the bank goes bust, the government’s indebtedness does not increase.

  • Posted by Michael Pettis

    RebE, if you mean the PBoC simply buys bank equity, it takes on a highly procyclical investment that performs well when China doesn’t need good performance, and performs horribly at exactly the wrong time — i.e. the value of the asset plummets during a domestic crisis, and so net indebtedness rises.

    If the banks need more equity they should bypass the PBoC altogether and simply issue equity in the market, especially now when Chinese banks are so heavily overvalued. The relative advantages of investing in Blackstone are supposed to be that a)China gets a transfer of financial technology and expertise, and b)Blackstone’s investment are (or should be, if they don’t invest too heavily in China) uncorrelated with the Chinese economy. Investing in their banks reverses the whole privatization process that they started a few years ago.

  • Posted by Guest

    ” What is the difference between a dollar investment in Blackstone and a Chinese bank? ”

    The difference is that Blackstone is an outbound destination for investment of fx reserves. Putting this money into Chinese banks just passes the problem of recycling dollars to another domestic entity. The Chinese banks are an intermediate source of the fx that’s sold to the reserve fund in the first place. If they’re capitalized in dollars, and can’t use the dollars, they may put the cash right back to PBOC. (They have to do something with the US cash from the capitalization.) If so, the net result is that the capitalization would have to be financed ultimately by more government indebtedness.

  • Posted by jkh

    I appreciate the US flexibility argument, but I think there is a bias in the causality. It’s not clear to me why excess consumption in the US isn’t a causal factor in enabling excess saving elsewhere. The decision to buy from Walmart more typically starts with domestic financing, leading to the export of dollars to China, and the recycling of dollars to the US. That process depends initially on domestic financing. But domestic financing did not specify consumption through international channels. That’s a US consumer choice.

    Also, foreign held dollars are ultimately captive to the US banking system. All dollars held globally ultimately clear toward the Fed – consider the mechanics of US dollar nostro accounts.

    So US flexibility enables the symbiosis of foreign saving with US consumption. But I don’t see the unidirectional implication of a net saving glut, especially one that is categorized by Bernanke as global. It takes two to tango.

  • Posted by RebelEconomist

    Michael:

    The banks should raise capital in the market, but if they are shaky, then that will be expensive. That is why the government are helping the banks by doing this.

    Guest on 2007-09-25 08:19:13:

    The government is no more indebted than it would have been if it had used the dollars to buy treasuries, and the same amount of dollar assets are acquired by China. One way of doing such an operation that might make this clearer would be for the government to simply swap US treasuries with a bank in return for an equity stake. The bank’s capital is increased, and the dollars remain invested so that no market transaction is involved. If the bank’s equity is denominated in renminbi, the bank has an increased exposure to the dollar and the government has a decreased exposure to the dollar, but this does not really matter, since this is not an profit-making transaction anyway; it is about helping the bank, by allowing it to run with less capital raised and remunerated at market rates.

  • Posted by Guest

    RebelEconomist on 2007-09-25 09:18:57

    You keep changing the story.

    Now you’re doing a treasury swap, converting the capitalization currency, forcing a currency mismatch into the bank, and creating an RMB asset on the books of PBOC.

    To what end I don’t know.

  • Posted by RebelEconomist

    Guest on 2007-09-25 09:40:58:

    The end is to boost the capitalisation of the banks. The example of transferring a US treasury was just to show you that no extra dollar purchases, foreign exchange transactions or government indebtedness need be involved. I do not know whether that is how such an operation would actually be done.

    The Chinese government have already established a state entity to do something like this, called Central Huijin Investment Company, which I believe was financed from the reserves.

  • Posted by Twofish

    Using government assets to capitalize banks has to be done carefully, otherwise the banks will expect a bailout the next time something goes wrong. The 1998 recapitalization could be justified that in the early 1990′s, Chinese banks found themselves holding lots of bad loans that the government ordered them to pay out as social welfare benefits. That wouldn’t be an excuse today. A trillion dollars might seem like a lot of money, but it is amazing how quickly it can disappear.

    If the banks need money, then can go out and issue stock, and doing that way encourages the banks to be profitable. I don’t think that three of the big four banks are shaky. What happened in 1998, was that three of the four banks, got their bad debt exchanged for good debt, and the bad debt got warehoused in another company where it is being dealt with by the government. Ultimately the government will have to pick up about 80% of the bad debt, but by not having the transfer go directly to the bank, the government was avoiding throwing good money after bad.

    If anyone of three of the four banks get themselves in trouble with post-1998 deals, then the entire upper management needs to be fired before we even talk about new money coming in.

    The difference between Blackstone and the Chinese banks was that Blackstone was supposed to be better at investing Chinese capital. It was an experiment that doesn’t seem to have turned out well.

  • Posted by Twofish

    Except for the Agricultural Bank of China, the big state banks have excellent balance sheets and are in no need of capitalization. The problem is that people aren’t sure about what happens once the business cycle shifts. I’m pretty much an optimist, but that is the big problem.

    ABC is going to get a cash infusion, but ABC’s problems are part of a bigger problem which is that farm incomes are not increasing. There are also huge problems with the rural credit cooperatives. Also, I don’t think that Central Huijin should be buying any of the city banks right now. What it should do is to have cash on hand so that if any of the JSCB’s do go under, Huijin can buy the bank, fire the management, and fix the problems.

    I had strongly objected before to making Huijin part of CIC, but I withdraw my objections after seeing that they are going to be putting the National Social Security Fund in charge of all of this. NSSF has a very, very strong incentive to make sure that the companies it owns are managed profitably and professionally (lots of old people who are going to want their money).

  • Posted by Twofish

    The goal of CIC appears to be one large pension retirement fund, which has been done successfully in other places. At least to start out with, it isn’t even going to be a particularly big pension fund. At $200 billion, CIC will smaller than Calpers (the California State Pension Fund) has about $250 billion of assets.

    If you look at the structure of CIC, it looks similar to the way the Calpers board is structured. Also the interesting thing is that one agency that is not at the table is the State Asset Supervision and Administration Council. This nicely divides up the states “ownership” and “regulatory” roles.

  • Posted by Anonymous

    Blackstone…Talk about shoddy, defective products.

  • Posted by Guest

    Increase in risk appetite??

    Only if lending to the sovereign govt. of the world’s reserve currency at negative real interest rates, funding its military adventures, and claims against the future salaries of it’s citizen’s, risky.

    Mmmmm now come to think of it maybe you are right!! What are the dollar and the national debt doing and going to be doing!!