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Borders still matter; “the world isn’t as flat as it used to be”

by Brad Setser
April 29, 2008

On Monday, Bob Davis of the Wall Street Journal argued that the world isn’t flat, or at least it “isn’t as flat as it used to be.” National borders matter more. Barriers to the free flow of goods – oil as well as grain – are rising. Barriers to the free flow of capital too.

He is right. I actually think he didn’t push his thesis as far as it could be pushed.

Consider energy. Most oil exporters sell their oil abroad for a higher price than they sell their oil domestically. That means that the same good has one price domestically and another price internationally. It isn’t hard to see why they have adopted this strategy: if opening up to trade raises export prices, it can leave those who consume the country’s main export worse off. Only exporting what cannot be sold domestically is one way of mitigating that effect. And for most of the oil exporters, it is one (small) way of sharing the bounty that comes from the country’s resource wealth.

This isn’t new. Saudi Arabia and Russia have long sold oil domestically at a lower price than internationally. What is new is that a host of food exporters are adopting a similar policy.

Argentina was perhaps the first. After its devaluation it taxed its agricultural exports – that was a way of raising revenue, but also a way of keeping food cheap domestically. As global prices have increased, Argentina has stepped up its restrictions on say beef exports – helping to keep Argentina’s national food affordable domestically.

Argentina’s farmers aren’t happy. They prefer selling for a higher price abroad than selling for a lower price domestically.

But with food prices rising, more and more countries seem to be adopting the same policies for their rice and wheat that Saudi Arabia and Russia have adopted for their oil. They only export what cannot be sold domestically at a price well below the world market price. That helps domestic consumers at the expense of domestic producers.

It also is a way – per Rodrik (“if you are Thailand or Argentina, where other goods are scarce relative to food, freer trade means higher relative prices of food, not lower”) — of assuring that the consumers in a food exporting country aren’t made worse off by trade.
Actually, in the current case, it is more a way of assuring that consumers in exporting countries aren’t made worse off from a shock to the global terms of trade that dramatically increased the global price of a commodity. But the principle is the same.

Such policies have produced a more fragmented world. Beef is cheaper in Argentina than in the rest of world. Rice is cheaper in rice-exporting economies than many rice-importing economies. Oil is cheaper in oil-exporting economies. And so on.

Then throw in the subsidies that many oil and food consumers have adopted to mitigate the impact of higher oil prices. China sells oil domestically at a price below the world market price. The Saudis are subsidizing food imports. That implies that the same good sells for a different price in “importing” countries – not just for a different price in importing and exporting countries.

For all the calls to adopt a coordinated response that guarantees that exporters won’t take steps — like taxing exports — that hurt the importers as well discouraging increased production in the exporting economy, my guess is that the food crisis will produce more government intervention in the market, not less.

Put it this way: after seeing various food exporting countries take policy steps that would reduce their countries’ profits from exporting to keep domestic prices low, is China’s government more or less likely to trust the market to deliver the resources the Chinese economy needs for its ongoing growth? Or will China conclude that it needs to invest and exercise some control in the production of the resources if it wants to guarantee the stability of its supplies?

Then there are capital flows. Davis highlights the growing presence of sovereign wealth funds in global markets and — – citing a forthcoming Council on Foreign Relations report by David Marchick and Matthew Slaughter — the possibility that the US and Europe will respond to the rise of state investors by stepping back from their existing, fairly liberal, policies for inward investment. He also notes that many countries with sovereign funds looking abroad limit investment in their own economies. China is a case in point.

Here I don’t think Davis goes far enough.

Sovereign wealth funds are a lot smaller than central banks. Their assets aren’t growing anywhere near as fast. The overall increase in the presence of the world’s governments in financial markets is much broader and deeper than an analysis that focuses on just sovereign funds would suggest.

MORE FOLLOWS

There are two big reasons for the rise in the state in cross border capital flows.

The first is that the state in most oil exporting economies controls the revenue from the commodity windfall. In aggregate, the oil exporters are sending more of the revenue globally from $120 a barrel oil back into global financial markets than they are spending or investing at home. Most oil exporters could cover their import bill with $50 or $60 a barrel oil. Some of this surplus goes into sovereign funds – but a lot is going into the hands of central banks. Think of the Bank of Russia, which manages Russia’s sovereign fund, or the Saudi Monetary Agency.

The second is that many states are resisting market pressure for their exchange rates to adjust. China is the obvious example. That requires intervening in the market. Jim Fallows put it well.

But saying that China has a high savings rate describes the situation without explaining it. Why should the Communist Party of China countenance a policy that takes so much wealth from the world’s poor, in their own country, and gives it to the United States? To add to the mystery, why should China be content to put so many of its holdings into dollars, knowing that the dollar is virtually guaranteed to keep losing value against the RMB? And how long can its people tolerate being denied so much of their earnings, when they and their country need so much? The Chinese government did not explicitly set out to tighten the belt on its population while offering cheap money to American homeowners. But the fact that it does results directly from explicit choices it has made—two in particular. Both arise from crucial controls the government maintains over an economy that in many other ways has become wide open. The situation may be easiest to explain by following a U.S. dollar on its journey from a customer’s hand in America to a factory in China and back again to the T-note auction in the United States.

Let’s say you buy an Oral-B electric toothbrush for $30 at a CVS in the United States. I choose this example because I’ve seen a factory in China that probably made the toothbrush. Most of that $30 stays in America, with CVS, the distributors, and Oral-B itself. Eventually $3 or so—an average percentage for small consumer goods—makes its way back to southern China.

When the factory originally placed its bid for Oral-B’s business, it stated the price in dollars: X million toothbrushes for Y dollars each. But the Chinese manufacturer can’t use the dollars directly. It needs RMB—to pay the workers their 1,200-RMB ($160) monthly salary, to buy supplies from other factories in China, to pay its taxes. So it takes the dollars to the local commercial bank—let’s say the Shenzhen Development Bank. After showing receipts or waybills to prove that it earned the dollars in genuine trade, not as speculative inflow, the factory trades them for RMB.

This is where the first controls kick in. In other major countries, the counterparts to the Shenzhen Development Bank can decide for themselves what to do with the dollars they take in. Trade them for euros or yen on the foreign-exchange market? Invest them directly in America? Issue dollar loans? Whatever they think will bring the highest return. But under China’s “surrender requirements,” Chinese banks can’t do those things. They must treat the dollars, in effect, as contraband, and turn most or all of them (instructions vary from time to time) over to China’s equivalent of the Federal Reserve Bank, the People’s Bank of China, for RMB at whatever is the official rate of exchange.

With thousands of transactions per day, the dollars pile up like crazy at the PBOC. More precisely, by more than a billion dollars per day. They pile up even faster than the trade surplus with America would indicate, because customers in many other countries settle their accounts in dollars, too.

The PBOC must do something with that money, and current Chinese doctrine allows it only one option: to give the dollars to another arm of the central government, the State Administration for Foreign Exchange. It is then SAFE’s job to figure out where to park the dollars for the best return: so much in U.S. stocks, so much shifted to euros, and the great majority left in the boring safety of U.S. Treasury notes.

….

At no point did an ordinary Chinese person decide to send so much money to America. In fact, at no point was most of this money at his or her disposal at all. These are in effect enforced savings, which are the result of the two huge and fundamental choices made by the central government.

One is to dictate the RMB’s value relative to other currencies, rather than allow it to be set by forces of supply and demand, as are the values of the dollar, euro, pound, etc. …This is what Americans have in mind when they complain that the Chinese government is rigging the world currency markets. … Once a government decides to thwart the market-driven exchange rate of its currency, it must control countless other aspects of its financial system, through instruments like surrender requirements and the equally ominous-sounding “sterilization bonds” (a way of keeping foreign-currency swaps from creating inflation, as they otherwise could).

These and similar tools are the way China’s government imposes an unbelievably high savings rate on its people. ….

The other major decision is not to use more money to address China’s needs directly—by building schools and agricultural research labs, cleaning up toxic waste, what have you. Both decisions stem from the central government’s vision of what is necessary to keep China on its unprecedented path of growth.

The controls on Chinese capital outflows – including the surrender requirement Fallows describes – have been liberalized. China’s banks are now being encouraged to hold dollar these days. But no one in China wants to hold depreciating dollars rather than appreciating RMB, so folks with dollars are still selling their dollars to the government if they can. Conversely, China is continuously tightening its controls on capital inflows. It is also tightening its controls on the banking sector – by raising reserve requirements and forcing the banks to lend funds to the state.

Holding its exchange rate down has a host of subsidiary effects. It creates pressures for price controls (see the Gulf) to limit inflation. And in China, it means that the government has a de facto monopoly on outward capital flows.

China now has the world’s largest current account surplus. That makes it – -and specifically its government – the world’s largest external investor. Ongoing inflows (despite the controls) only add to the funds that China’s government has to invest abroad.

And the process for deciding what to buy remains driven by the state. Consider Richard McGregor’s description of the Chinalco investment in Rio Tinto.

The Aluminum Corporation of China, or Chinalco, spent $14.1bn in conjunction with Canada’s Alcoa, a junior partner in the transaction, to buy into Rio’s UK-listed arm. Executed in a lightning share raid, Chinalco’s purchase is the largest ever single Chinese investment offshore.

….

As a huge and growing consumer of commodities, China’s concern about the BHP takeover is unsurprising. Nor is Chinalco’s denial that the Rio raid had anything to do with the BHP bid. Such po-faced obfuscation is standard in corporate jousting around the world.

Disentangling Chinalco from China, and China Inc, however, is a much harder proposition. BHP and Rio are dealing with a huge number of demanding shareholders. Chinalco’s investor relations are a lot more straightforward. Its overseas listed subsidiary aside, Xiao Yaqing, Chinalco’s chairman, answers to a single shareholder – the Chinese state. Mr Xiao himself serves at the pleasure of the ruling Communist party’s human resources arm, known as the “Organisation Department”, which oversees all top executive appointments in state enterprises. …

Chinalco’s purchase was funded by the China Development Bank, a state policy bank, a shareholder of which is the country’s sovereign wealth fund, the China Investment Corporation. The sovereign fund, further, owns the largest Chinese investment bank, which is advising Chinalco.

The ambitious CDB itself is no stranger to doing the state’s business offshore. It has been given crucial government mandates, most importantly to fund the expansion of local companies in Africa, primarily for resource projects.

In short, you do not have to be a rabid conspiracy theorist to conclude that Chinalco is a front for China Inc. “Why does BHP really want to tempt the dragon? Chinalco has already made the message clear: they really do not want to see a merger,” Geoffrey Cheng, of Daiwa Institute of Research in Hong Kong, told Reuters. “You’re not going against a corporation. You’re going against a nation.”

….

The second point is the more salient one – the perception that Chinalco represents “the nation” in this transaction. A world waking up to a new fact of life in the global economy, the phenomenon of Chinese offshore investment, is naturally going to see a tangled monolith.

McGregor notes that different state bodies often have diverging interests — so the assumption that China, inc functions as a monolith is wrong (see his article with Geoff Dyer) But his description of the various ways China’s state was involved in the Chinalco bid underscores is hard to reconcile with a world where the state has retreated from the market …

59 Comments

  • Posted by r0tiNeK

    That was a Great article by Bob Davis in the WSJ yesterday. Spot on. Emerging Protectionist Themes are really going to play a significant role going forward.

    It’s quite ironic that the US was extolling the virtues of Globalisation (when it was in their best interests) & now even the US is starting to Publicly bolster Fascist policies.

  • Posted by Qingdao

    Recent article in http://www.eeo.com.cn describes "Chinese firms tapping informal loan networks" illegally, because they cannot get a loan from the big state banks – and paying 5% a MONTH. It would be nice to know how much of this is "hot money."

  • Posted by Twofish

    The problem with the Fallows argument is that it reverses cause and effect. In order to sterilize the incoming dollars, the PBC has to have lots of cash RMB deposits available from the banks, and the decision to store lots of RMB in banks was a decision by ordinary Chinese. Absent a large pool of domestic savings, the PBC couldn’t absorb as many dollars as it has without triggering inflation.

    The thing that totally demolishes his argument is that household domestic savings have been roughly constant since 1978. Enterprise savings rates have mushroomed since 2000, but that’s because corporations now are making money. It’s the high savings rate that allows the government to prevent appreciation rather than the other direction.

    Also….

    Fallows: The other major decision is not to use more money to address China’s needs directly—by building schools and agricultural research labs, cleaning up toxic waste, what have you. Both decisions stem from the central government’s vision of what is necessary to keep China on its unprecedented path of growth.

    The problem here is that the government is spending money as fast as possible in order to build schools. The limiting factor is not money, it’s just that you can’t take a trillion dollars and create a university system and universal health care system overnight. It takes about four or five years.

    By 2012, there should be a system of free education up until the ninth grade and universal health insurance.

  • Posted by Twofish

    bsetser: But his description of the various ways China’s state was involved in the Chinalco bid underscores is hard to reconcile with a world where the state has retreated from the market …

    In other news the Fed has given JPMorgan a non-recourse loan to buy Bear Stearns, and opened its discount window to broker-dealers, and is currently formulating new regulations on how this is to be done.

    I don’t see the state retreating from the market at all.

  • Posted by HZ

    "At no point did an ordinary Chinese person decide to send so much money to America. In fact, at no point was most of this money at his or her disposal at all."

    This is rather bogus. If Chinese didn’t save at individual and corporate/government level there would not be an overall surplus. While the C/A surplus may be large it is not a dominating factor of the GDP. Not even a dominating factor of the savings. Most savings go into domestic investment. The large surplus comes from savings in excess of investment, coupled with a policy of attracting FDI.

    China is going through rather high inflation right now. Inflation last year combined with projected inflation this year will be in the neighborhood of some 13%. So not all tradeoffs will be in the Fx rate. There is also one between savers and income earners.

    As far as enforced savings goes, it has at least as much (if not more) to do with a lack of social safety net and slack enforcement of labor and environmental laws as with the exchange rate.

  • Posted by Twofish

    bsetser: is China’s government more or less likely to trust the market to deliver the resources the Chinese economy needs for its ongoing growth?

    Since many of the critical resources (notably oil) are outside of China’s borders, it really doesn’t have much choice in the matter. Even if it tries to get equity stakes in mines and oil fields, that’s still going through the market.

    McGregor: In short, you do not have to be a rabid conspiracy theorist to conclude that Chinalco is a front for China Inc.

    I’m sure that the people at Chinalco would like people to think that the government is fully backing them, but it isn’t so. Chinalco is one of three aluminum companies in China, and there is no particularly reason why it should get favorable treatment over the other two.

    The Chinese government is one giant bureaucracy, and like all giant bureaucracies there is a huge amount of internal feuding. The reason the Chinese economy works as well as it does is that the government has created a system in which bureaucratic infighting becomes something that resembles market competition.

  • Posted by Peter

    Excellent post. Makes me itchy to make a comment.

    Flat world or not, it is just scratching the surface. It is much more deeper, critical, fundamental and philosophical about our world. When we add, USD+Crude oil(resources)+China,.. maybe a better title, "God’s Diktat: Endgame for Civilization" ?

    Market mechanism is morally neutral. (The Europeans – the tyrannical force of the free market, or, as what Carnegie said, – "The public be damned, I work for stock holders").

    Why can’t a precious commodity (i.e. crude oil) runs like the diamond market (i.e. maximization of profit for owners like De Beers) ?

    Why can’t China trust the market to deliver (in this case, iron ore)? …Well,….. delivery (of the iron ore) like the crude oil market or the diamond market?

    Talk is cheap. In the end, it is give-and-take. For China, the experience went back to 1998.

    When the deal about the Tengiz oil field (by the Caspian sea, Kazakhstan) came up, several far-sighted planners tried to use this opportunity to induct China "into the club". Joined by ENI, Total, Mobil, BP, China is to have a -modest by today’s standard- 20% stake. But it was 1998, China was not as huge as 2008. Then SOMEONE HIGH IN THE COMMAND CHAIN ABOVE MOBIL had a different thought and was obviously TOO SMART BY HALF, engineered a coup – China got squeezed out in the last second. Decision makers involved are further distressed that China remained eerily silent – a sure sign to all the China experts that one day the chickens will come home to roost. Today, the designated fall guys from Mobil (a consultant and a high ranking manager) are still in legal proceedings for bribery charges in New York federal court for this case. But the question is, Can the confidence building be restarted even with a guilty verdict?

  • Posted by Guest

    "now even the US is starting to Publicly bolster Fascist policies."

    Agreed that the Bush govt has adopted many policies that could be qualified as "Fascist", but in this case "Mercantilist" would not only be more nearly neutral but also more accurate.

  • Posted by Rachel

    Speaking of domestic policies – an interesting article in Economic observer described how Chinese rice policies and transportation backlogs are leading to oversupply in some region

    http://www.eeo.com.cn/ens/Industry/2008/04/16/96981.html

    another part of the picture is also the differential pricing energy exporters charged to purchasers – eg the tendency of Russia to underprice gas to CIS countries and to demand below market costs from CIS gas exporters for onward export to Europe. This system though is shifting.

  • Posted by Guest

    Interconnected doesn’t mean flat, or free of complication or complexity. As far as international economics is concerned, it’s not obvious what the word flat should mean (other than flat tax, etc.). Words matter. Friedman might have chosen a better one for his title.

  • Posted by bsetser

    HZ — the decision to use China’s wealth to fund the CIC rather than to finance rural health care/ a social safety net was a policy choice. 2fish — the decision not to distribute SOE profits (and to restrict bank lending to firms/ force the banks to funnel funds to the PBoC/ SAFE) was also a policy choice. The fact that China’s personal savings rate hasn’t increased supports Fallows thesis rather than undermines it. I would have written a few of the details differently, but the core of his argument stands — China has a heavily managed exchange rate (state involvement), lots of capital controls that put most of the fx in the states hands (they have been loosened a bit, but at a time when there is an economic incentive to hold rmb not $ so the result is the same), a managed banking system (controlled deposit and lending rates, mandatory reserves, guidance to buy sterilization bills, quantitative restrictions on lending) and a host of state policies that have pushed up national savings (the decision not to borrow to finance rural health care, the absence of any distribution of SOE profits to fund other government activities, etc).

    The Bear Stearns example — and more broadly the expansion of the Agencies/ federal home loan bank lending — would provide additional support for Davis’ thesis. THe uS Governments has become a bigger players in the US market as well.

  • Posted by DC

    " In Asia, despite the deepening US economic dependence on China to sustain to the rapidly depreciating US dollar (China holds $1.5 trillion dollars in foreign reserves which has lost 60% of its value since 2002), the US militarists still engage in sustained anti-Chinese propaganda campaigns and highly provocative incidents. The US-backed violent protests against the Chinese presence in Tibet fomented by the Dalai Lama and CIA-funded exile organizations is only the more recent example. US Intelligence Agencies have also directed a political campaign against the expansion of Chinese investments and contracts (market-driven imperialism) in the Sudan.

    China has so far generally overlooked US military provocations such as the shooting down of a Chinese fighter plane, spy flights over Chinese offshore territory, the deliberate bombing of its embassy in Belgrade and the sale of advanced missiles to Taiwan. The US financing of the separatist demonstrations among Tibetan exiles is designed to tarnish China’s image in the lead up to its hosting the 2008 Summer Olympics. China’s market-driven empire builders ignore US military provocations because they had little effect on Chinese overseas and domestic economic expansion. Nevertheless China has increased spending on modernizing its military defense capabilities. More significantly, as the US economy declines and enters a deep recession in 2008, and as the dollar continues to fall ($1.60 to 1 Euro as of May 2008), China has turned toward the Asian, European, Middle Eastern markets. Asian markets now account for 50% of world trade growth as of 2008. In 2007 China increased production and the development of its market to sustain growth rates at least five times higher than the militarist-dominated US Empire. Even more significant, the great majority of Chinese exporters (over 800,000) have shifted payments to Euros, Yen, Pounds Sterling and the Renminbi in its trading with non-US trading partners. "

    http://www.globalresearch.ca/index.php?context=va&aid=8841

  • Posted by DC

    Another little stake in the heart of US Dollar hegemony …

    Chinese Exporters Demanding Payment in Euros

    http://www.nytimes.com/2008/04/30/business/worldbusiness/30yuan.html?_r=1&ref=business&oref=slogin

    GUANGZHOU, China — Facing the double-barreled threat of a falling dollar and weakening American demand, some Chinese exporters are starting to ask European customers to pay in euros. Others are trying to increase domestic sales. Some European buyers have agreed to pay in euros, which protects them from the risk they previously took that the dollar would strengthen against the euro.

  • Posted by DC

    Now this is total injustice:

    " The US government has been involved in drawing up the Iraqi energy law, a draft of which has been seen by The Independent on Sunday. It would give big oil companies such as BP, Shell and Exxon 30-year contracts to extract Iraqi crude and allow the first large-scale operation of foreign oil interests in the country since the industry was nationalised in 1972.

    The huge potential prizes for Western firms will give ammunition to critics who say the Iraq war was fought for oil. They point to statements such as one from Vice-President Dick Cheney, who said in 1999, while he was still chief executive of the oil services company Halliburton, that the world would need an additional 50 million barrels of oil a day by 2010. "So where is the oil going to come from?… The Middle East, with two-thirds of the world’s oil and the lowest cost, is still where the prize ultimately lies," he said. "

  • Posted by Guest

    "…Rising numbers of Chinese exporters are shunning the US dollar or devising ways to offset the impact of the falling currency as they confront rising labour and raw material costs at home.

    According to Alibaba.com, the online company that matches Chinese suppliers with international buyers, the vast majority of their almost 700,000 Chinese suppliers no longer use dollars to settle non-US transactions to minimise foreign exchange risk…" http://www.ft.com/cms/s/0/aac6859e-fc35-11dc-9229-000077b07658.html

    "…America needs to make a new case for trade…" http://www.ft.com/cms/s/0/0c185e3a-1478-11dd-a741-0000779fd2ac.html "…We might find ourselves nostalgic for Bush, who is brave on trade…" http://fareedzakaria.com/articles/newsweek/031008.html

    "…the role that the Belgrade bombing seems to play as the creation myth of the birth of the 21st Chinese strategic military doctrine, founded on the assumption that the U.S. will unscrupulously use its military, diplomatic, and propaganda advantages not only to contain China but even to attack it when need, desire, and circumstances permit…" http://chinamatters.blogspot.com/2008/04/f117a-swan-song-fall-of-belgrade.html

  • Posted by Guest

    "…a long “China” position is not a forecast that financial globalization will succeed, but rather a bet that its internal contradictions will persist…" http://www.hoover.org/publications/policyreview/14801241.html

    "…economic inequality makes democracy repugnant to elites and attractive to the masses. It is a recipe for civil conflict and unstable democracies. But a sizeable middle class is conducive to democracy: civil society is stronger, while the dangers of unbridled populism are reduced…" http://us.ft.com/ftgateway/superpage.ft?news_id=fto012420061534534572

  • Posted by bsetser

    DC — I am far less worried about the erosion of dollar hegemony than you are. The fact that cHinese exporters want euros not dollars/ are increasing their dollar prices is evidence of adjustment in action. It suggests — contrary to the arguments many have made in the comments here — that a rise in the RMB v the $ does have an impact on trade flows.

  • Posted by Twofish

    bsetser: HZ — the decision to use China’s wealth to fund the CIC rather than to finance rural health care/ a social safety net was a policy choice. 2fish — the decision not to distribute SOE profits (and to restrict bank lending to firms/ force the banks to funnel funds to the PBoC/ SAFE) was also a policy choice.

    CIC is the Chinese pension system. As it is CIC will have a tough time funding existing state commitments.

    Choice implies that other viable options, and in the cause of rural health care / social safety net / and SOE dividends, they are constraints that reduce the options available. In particular, it’s just not the case that you can make a decision in Beijing to spend $500 billion on rural health care and have it happen, and the fact that it took Beijing a decade to figure out how to put together a health care system is I think excellent work.

  • Posted by Twofish

    Also, it’s amazing how in politics and economics, things sometimes just happen without anyone making a conscious decision to do something. I don’t think anyone in Beijing every thought to themselves "let’s accumulate $2 trillion in US reserves." People make a decision here, a decision there. Most of the time, no decision is made and things just go on auto-pilot.

  • Posted by Twofish

    Big oil is responsible for a lot of evil in the world. But the Iraq War was not one of the them. Most US oil companies would have prefered to just deal with Hussein.

  • Posted by bsetser

    2fish — the CIC is a sterilization mechanism more than a pension system. it will likely produce losses over time (RMB liabilities, fx assets) that the taxpayer will absorb. Moreover, its external assets are only really useful to cover pensions if an aging china starts running trade deficits financed by either the income on its external assets or selling down its external assets.

    I am not with you on this; the CIC looks like a loss-making intermediary more than anything else.

    I also don’t buy the constraints argument. at the limit, China could use the funds raised for the CIC to write a check to all of China’s citizens to give them more money to spend on health care/ education through the existing system. Or it could fund a huge school building scheme to employ some of the workers shed from low-wage manufacturing as the RMB appreciates.

  • Posted by Guest

    check out Prasad…

    "…It is a good thing, surely, to allow these vast sums to move to where they can be used most productively and to permit residents of each country to invest in a globally diverse range of assets. But a closer look reveals curious – and arguably problematic – aspects of the patterns of capital movement.

    While poor and middle-income countries are receiving large sums of private capital, they are actually exporting more capital than they are getting… this is not to say that financial integration has no discernible benefits. Indeed, there is accumulating (if only circumstantial) evidence that integration yields strong indirect benefits. Openness to foreign capital appears to catalyze the development of domestic financial markets, as well as to add to political pressure to improve the climate for modern enterprise…

    The fact that financial integration yields powerful indirect benefits in the long run but can exacerbate economic problems in the short has important implications… a trillion and a half dollars in the central bank and the willingness to use it could go a long way toward preventing panic during a financial crisis. Thus, the strategy of running big current-account surpluses may permit developing countries to proceed down the path of financial integration without fully exposing themselves to the transitional risks…" http://www.milkeninstitute.org/publications/review/2008_4/36-43mr38.pdf

  • Posted by Guest

    "…Removing the burden of maintaining the exchange value of the renminbi could trigger a virtuous cycle that speeded financial sector reform and sharply reduced the level of wasteful investment that now absorbs so much of China’s savings… In an ideal world, relatively capital-poor economies would have better financial systems that would allow them to channel both domestic savings and foreign capital to their most productive uses… But this isn’t an ideal world. And rather than asking whether “uphill” capital flows reflect irrational behavior, it would be useful to ask what these seemingly perverse international financial flows are signaling… they are a sign of things gone awry…"

    "…In Australia, for instance, water rights can be traded. When the country was hit by drought, the price of those rights rose, and wheat growers started selling their water rights to the vineyards, because doing so was more profitable than growing wheat. And that, in turn, contributed substantially to the rise in global wheat prices.

    The world would be better off right now if Australia’s wheat growers had continued to grow wheat, and if Australia’s wine growers had simply produced less wine. But that’s not how the market incentives played out…" http://www.portfolio.com/views/blogs/market-movers/2008/04/29/the-unintended-consequences-of-water-pricing

  • Posted by Sargon TM

    bsetser:

    "Put it this way: after seeing various food exporting countries take policy steps that would reduce their countries’ profits from exporting to keep domestic prices low, is China’s government more or less likely to trust the market to deliver the resources the Chinese economy needs for its ongoing growth? Or will China conclude that it needs to invest and exercise some control in the production of the resources if it wants to guarantee the stability of its supplies?"

    It is interesting to compare the content of the above paragraph with the speeches of pro-empire politicans in the nineteenth century. There were several reasons why countries wanted to manipulate the politics of (aka rule, one way or another) other countries, and economic integration was one of the most important.

    The industrial organization pendulum swings back and forth between the improved incentives associated with markets, which push non-core activities out of the firm, and the improved coordination associated with ownership, which pulls non-core activities back into the firm.

    Aggregation and disaggregation of empires is the same phenomenon on a larger scale. We also know what is needed to encourage disaggregation, which is to everyone’s long-term benefit: cross-national property rights that are effectively enforced.

    Well, I can dream.

    Sargon TM

  • Posted by DC

    Twofish,

    The Big oil Lobby was NOT responsible for the Iraq war. However, Iraqi Oil reserves that are the world’s 2nd largest played a major role in the decision making of the Bush Administration to invade and occupy Iraq. As Paul Wolfowitz stated, "The exploitation of Iraqi oil reserves will entirely cover the US financial cost of the war". Under United Nations legal framework, the exploitation of another sovereign nation’s natural resources by an occupying power is illegal.

  • Posted by DC

    "contrary to the arguments many have made in the comments here — that a rise in the RMB v the $ does have an impact on trade flows. – Brad"

    Brad, I never stated that the rise in the RMB would not have any impact on trade flows, the the RMB rise hasn’t been a panacea for the structural imbalances within the domestic US Economy. I predict the US Trade Deficit will correct simply because the typical US consumer or "Joe6pack" is flat broke after filling the tank of his gas-guzzler SUV and paying the adjustible rate mortgage on his McMansion. Whatever monetary policy the China PBoC decides upon is immaterial to the prosperity or looming deep recession of the US Economy. Intra-Asian markets now account for 50% of world trade growth as of 2008. Less than a quarter of China’s trade is dependent on the US Economy.

  • Posted by Twofish

    bsetser: (the decision not to borrow to finance rural health care, the absence of any distribution of SOE profits to fund other government activities, etc).

    Actually China did borrow very heavily to finance rural health care and education. Why do you think the all of the non-performing loans come from? The problem with borrowing to financial rural health care and education is that borrowing doesn’t fix the problem. You need transfer payments, and that implies a national taxation system which got put together in 1993-1995.

    As far as the SOE’s go. The Chinese government made a decision in 1983 to let SOE’s keep their profits. The problem is that if SOE’s don’t keep their profits, then what incentive is there for SOE managers to make a profit in the first place. There’s also the problem that by taking dividends from profitable companies, you have to make sure that you don’t create incentives to increase losses. Now SOE’s are making money we can figure out where to put the dividends.

    bsetser: Moreover, its external assets are only really useful to cover pensions if an aging china starts running trade deficits financed by either the income on its external assets or selling down its external assets.

    Which could happen. We are looking about twenty years in the future.

    bsetser: I am not with you on this; the CIC looks like a loss-making intermediary more than anything else.

    CIC is run by the National Social Security Fund. It’s the designated reserve fund for the Chinese pension system. Once a provincial or local pension fund runs bankrupt (and most of them will) then the funds to pay pensions will come from CIC. The fund will see currency losses about 10-15%, but by shifting $200 billion in foreign exchange over to NSSF (which had about $30 billion) the Chinese government massively recapitalized the pension system. It’s been recapitalized with depreciating assets, but its been recapitalized.

    bsester: I also don’t buy the constraints argument. at the limit, China could use the funds raised for the CIC to write a check to all of China’s citizens to give them more money to spend on health care/ education through the existing system.

    There is no existing system. The system of socialized medicine fell apart in the late 1990′s, and writing a check won’t fix the problem. You write someone a check to pay for health care. He spends it on food and then gets hit by a truck. What do you do? Or he doesn’t spend on food, and saves it for when it gets hit by a truck, so it goes back into the banking system. Also the amount of money that you need to spend on health care if you get hit by a truck is far more than what that check was for, so you need some form of insurance.

    bsetser: Or it could fund a huge school building scheme to employ some of the workers shed from low-wage manufacturing as the RMB appreciates.

    The buildings are there. The big problem is teacher salary. You have to boost salaries to compete with the manufacturing jobs in the cities, and rural counties are broke. If rural countries raise taxes, charge fees, or sell land to pay for teacher salaries, then you get riots. So again, you need transfer payments. The trouble then is that you need to make sure that the money goes to the teacher and not some corrupt official’s pocket, and that takes a lot of effort to get right. Five to ten years.

  • Posted by Guest

    well you would also need to look at "corporate empires" then — multinationals — as much as national ones (as opposed to city-states); disaggregation in this sense is akin to exposing databases and APIs to the public, effectively inverting the corporation (in a Coasean sense) to individual control [cf. http://www.marginalrevolution.com/marginalrevolution/2008/04/limited-liabili.html & Reich’s "Supercapitalism"]…

    in this way, if we: "Exploit technology and put the prices online where they can be easily adjusted… If all prices are perfectly flexible, markets will behave optimally on their own and there would be no need for the Fed to intervene to stabilize the economy…" http://economistsview.typepad.com/economistsview/2008/04/fading-power-at.html

    in which case: "…this was in fact a big one-time shift, more analogous to the industrial revolution than to flagpole-sitting… assume that media includes consuming, producing and sharing… trying to figure out how to deploy this cognitive surplus…" http://www.herecomeseverybody.org/2008/04/looking-for-the-mouse.html

    "…with all the world so busily engaged in trying to find things out, that we would end up, somehow, figuring things out…" http://www.salon.com/tech/htww/2007/10/30/google_brain/index.html

    well, then, perhaps via a new global financial/monetary architecture and maybe even new (non-national) currency systems — http://www.kuro5hin.org/story/2003/8/26/172939/637 — we may finally make the round trip back to Schumpeter:

    "…if distribution can be described by means of the social marginal utilities of the factors of production, it is not necessary, for that purpose, to enter into a theory of prices. The theory of distribution follows, in this case, directly from the law of social value… that is much more lucid and attractive than that derived from an intricate and cumbersome theory of prices…" http://www.marxists.org/reference/subject/economics/schumpeter/value.htm

  • Posted by HZ

    Brad,

    A negative tax for the low income is pretty much the only way to get the effect you wanted right away, but I am not sure how comfortable politicians will feel about the idea. Also it needs to be a sustained negative tax so that it can be built into the expectations otherwise much of it gets put back into the savings right away. A universal pension system ala Social Security is probably a lot more palatable but the effect may not be instant if a lot of defensive savings are for education and medical care.

    There is a need to spend. Transfer payment is efficient but not easy politically. Other schemes are inefficient and could lead to corruption, over investment, and further entrenchment of the state in the economy.

  • Posted by bsetser

    2fish — the CIC didn’t just get $200b in assets. It also got $200b (more really) in RMB liabilities. I don’t see how that is a recapitalization! If the CIC doesn’t have to pay back the money the minfin borrowed to buy the fx it now manages, it is in great shape and has assets that could help meet the pension system’s liabilities (if china is willing to repatriate funds, which would put upward pressure on the rmb … ). But if that was the goal, china could have recapitalized the pension more effectively by borrowing rmb 1.55 trillion and handing the rmb cash over to the pension system with a message to the effect of "don’t worry about paying this back"

    Borrowing in rmb to buy fx is not the way to recap a domestic pension system!

    HZ — why didn’t China do the transfer? it has the cash (see SOE profits). Or it can raise the cash easily (see the CIC bond issue … ). buying depreciating fx assets is usually a hard sell politically too …

    SargonTM — interesting points

  • Posted by Twofish

    I do have a bit of impatience with economists sometimes. Change a number on a spreadsheet, move a supply curve, what could be easier? The trouble is that once you get on the ground, things aren’t that easy. To delivery a health baby takes about nine months, and you can’t speed up the process by spending more money on it, and very bad things will happen if you try.

    To create a viable taxation system, a health care system, an educational system, a pension system, a system of industrial corporations, a banking system takes years, and you aren’t going to speed up the process by spending more money.

    Hu Jintao just can’t order SOE’s to pay more dividends and have it happen. It takes drafts, proposals, counter-proposals, negotiations, and lots and lots of meetings. It can be done but if he is in the "SOE dividend meeting" then he can’t go to the "rural healthcare infrastructure meeting" which means that there is a limited number issues that can get Hu’s attention. Lower ranking officials can handle things but the lower the official, the less room there is to deviate from the autopilot settings.

  • Posted by Twofish

    bsetser: If the CIC doesn’t have to pay back the money the minfin borrowed to buy the fx it now manages, it is in great shape and has assets that could help meet the pension system’s liabilities

    Basically, yes.

    bsetser: But if that was the goal, china could have recapitalized the pension more effectively by borrowing rmb 1.55 trillion and handing the rmb cash over to the pension system with a message to the effect of "don’t worry about paying this back"

    But then what do you do with the foreign exchange reserves, and where does the pension fund invest the 1.55 trillion domestically? The US has a huge infrastructure of fund managers that can absorb $200 billion in pension investments. China doesn’t, and the danger in writing a blank check is that you’ll run into what happened in Shanghai where the pension officials were stealing funds.

    The Chinese government has multiple sometimes conflicting goals, and CIC was designed to hit several goals at the same time. One should also point out that the pension fund got custody over Huijin.

    bsetser: HZ — why didn’t China do the transfer? it has the cash (see SOE profits). Or it can raise the cash easily (see the CIC bond issue … ).

    Because creating a tax infrastructure is non-trivial. How does one sign up to get the payments? How do you make sure that you don’t have someone signing up fifty people to get the payments. Etc. Etc.

    bsetser: buying depreciating fx assets is usually a hard sell politically too …

    It’s really not since no one sees the money leaving their pocket.

  • Posted by HZ

    Brad,

    As 2fish said, the infrastructure for the distribution could be difficult. Most of the low income people don’t have a bank account that you could just wire to. There is already a ssi type of payments for urban residents, which is pretty low so they could raise that. For rural areas they got rid of the agriculture tax. Higher prices for farm produces would also help.

    If you want to build an entitlement program, you can’t do it in secret. You need to broadcast it so that those who are entitled (who are also hard to reach) are informed. Now would those who don’t meet the entitlement criteria be angry? Esp. those who are close to the threshold? That is what I mean by "political difficulty". You could also be more efficient and achieve much of the effect by doing it flat and universal. But the thing is, to get the people to spend it, you need to build the expectation that this program will last. 1T reserve/1B comes to 1000 per head. So you can probably do 50-100 per head per year. Sounds reasonable. They should do it! :-) It will take a while to find out how much actually get spent though.

  • Posted by bsetser

    2fish and HZ — setting up the CIC took a ton of work/ requiring fighting a lot of bureaucratic battles and broke more than a bit of China. I don’t see why that effort couldn’t have been redirected toward finding ways of writing folks in rural china checks (tho the rise in rice prices may change the needs of urban and rural china around a bit). and 2fish, you wouldn’t even need to invest in the domestic stock market (which i concede poses problems, not the least those of timing … ); you could deposit the funds in the banks …

    but that would go against the government’s policy of restraining bank lending growth to support the exchange rate.

    frankly, this doesn’t make economic sense. it may make political sense in the same way that using reservse to recap the banks made political sense. but borrowing domestically to buy depreciating foreign assets and producing big fiscal losses over time is not the way to close a fiscal hole from pension fund commitments. it basically creates a new loss, not an asset — on top of the pension deficit, there is a deficit from the cic’s exchange rate losses. there is no net buildup of government assets from issuing debt in an appreciating currency to buy assets in a depreciating currency. you are better off not doing anything.

  • Posted by Twofish

    HZ: Higher prices for farm produces would also help.

    Which is why the government doesn’t seem to be in that much of a hurry to crack down on inflation. As long as inflation is in food, then the result may be to have urban dwellers save less and spend more on food, which is a wealth redistribution.

    HZ: You could also be more efficient and achieve much of the effect by doing it flat and universal. But the thing is, to get the people to spend it, you need to build the expectation that this program will last.

    And it’s going to be hard sell given that the government laid off lots of people in the 1990′s. The trouble is that it will take about ten years to convince people that they should spend, by which time things could change so that they should be saving.

  • Posted by Twofish

    bsetser: I don’t see why that effort couldn’t have been redirected toward finding ways of writing folks in rural china checks

    It was. Universal health care, free education up to grade nine, and abolition of all rural taxes and fees will be done before the next party congress.

    bsetser: you could deposit the funds in the banks …

    At which point the banks would take the money and push the real estate bubble larger than it was. The goal was to get banks to lend less money, not more….

    bsetser: frankly, this doesn’t make economic sense. it may make political sense in the same way that using reservse to recap the banks made political sense.

    For these sorts of questions, politics ends up being more important than economics, since politics determines what people want to do, and what they can do.

    bsetser: there is no net buildup of government assets from issuing debt in an appreciating currency to buy assets in a depreciating currency. you are better off not doing anything

    You are looking at aggregate numbers rather than looking at who gets what. If you do nothing then you have the forex invested in US treasuries and you are looking at a 20% loss rather than a 10% one, and the pension fund is unfunded.

  • Posted by DC

    Brad,

    Foreigners visiting China tend to visit the showcase cities of Beijing, Guangzhou, Shenzhen, and Shanghai. Where the majority of the population actually lives, the other China is rarely visited by foreigners. Within China, there is an astonishing cultural clash between the urban cities and rural regions that has been well documented. There are two China’s that exist side by side, yet the people live in entirely different worlds. The myriad problems across rural China aren’t easily fixed by the China PBoC sending everyone a check to spend.

    Since you live in New York City, I highly recommend that you see a new Chinese movie entitled "Up the Yangtze" at the IFC Center near New York University.

    http://www.ifccenter.com/index

    http://www.uptheyangtze.com/

    Another movie documentary that I highly recommend is "Not One Less" which illustrates the school educational conditions across rural China.

  • Posted by DC

    The world was never that flat to begin with. Besides being the self-appointed foreign policy guru within the former Clinton Administration, Thomas Friedman was and still is an Neo-liberal idiot. Whatever economic policy that Robert Rubin would announce, Thomas Freidman would regurgitate it on the front page of the next day’s New York Times. Thanks to one of Thomas Friedman’s editorials, we also now know who is responsible for the Iraq war fiasco. "I can name 25 people in Washington that the Iraq war would have never happened without them", wrote Thomas Friedman. Sometimes his NYT editorials support the Iraqi invasion as a pitstop to Arab democracy, some other of his editorials denounce the Bush Administration. To truely understand a foreign culture or society, it takes alot more than a whirlwind tour of Baghdad Iraq, Lhasa Tibet or Shanghai China. Just my 2 cents.

  • Posted by Guest

    Robert Wyatt wrote a song in 1984 called “The Age of Self.”

    It’s a very nice song, talking about Rio Tinto working deads and working-class.

    Thacherism and Reaganism were bad, but Bushism will be the end-of-it-all.

  • Posted by bsetser

    Guest comments are for comments, not for cutting and pasting entire articles. short summaries (one para) and a link are fine; huge blocks of text are not. Because of the length of the comment, I deleted it. Sorry.

  • Posted by HZ

    Brad: "frankly, this doesn’t make economic sense. it may make political sense in the same way that using reservse to recap the banks made political sense. but borrowing domestically to buy depreciating foreign assets and producing big fiscal losses over time is not the way to close a fiscal hole from pension fund commitments."

    I agree and disagree. Pension funding is very long term investing. There is an obvious demographic problem with the Chinese population structure in that it will age faster than any other country historically due to the one child policy. So there is a great need for foreign asset in pension savings. But I agree that this shouldn’t be CIC’s purview since CIC is funded by debt. The pension funds/social security funds should instead be required to hold a percentage of their assets in foreign assets and be required to only invest through broadly diversified index.

    CIC, on the other hand, should be strategic investors not financial investors. However there is great resistance to that from the West if it takes the form of equity and control. Plus it does not have the expertise to be an equity investor. So what CIC should do is to primarily invest through debt investments in strategic industries. China obviously will need a lot of natural resources to continue its urbanization and raise the standards of living. Natural resources investments are traditionally very cyclical and cost of funding is high which limits supply and drives up commodity prices. What CIC could do is to provide a transparent lower rate and stable debt financing to companies engaged in agriculture, mining and energy industries. As only a debt investor, it would disavow of control of where the end products should go. But an increase of supply will benefit China regardless. It should be open and transparent so that any qualified company with a reasonable proposal for project could bid for funding. In other word, CIC should be the Fannie Mae or FHLB for strategic industries that could not be developed within China due to physical limitations.

  • Posted by Twofish

    HZ: The pension funds/social security funds should instead be required to hold a percentage of their assets in foreign assets and be required to only invest through broadly diversified index.

    The problem is that once you get over $30 billion in assets index investing no longer works, since you just have too much cash, and you’ll move the index against you. The other problem is which index, and who decides what stocks are in your index? Whoever decides what is in the index has become your fund manager.

    HZ: CIC, on the other hand, should be strategic investors not financial investors.

    China only allocated fraction of its foreign exchange reserves to CIC, and can easily start another investment fund if CIC is successful. The reason that China started with CIC first is several-fold:

    1) it’s a pressing need. Shanghai had just had a major scandal in which city pension money was pilfered and everyone knows that the PRC pension system is broke. Hu Jintao came to office on a "Great Society" platform so fixing the pension system is very high on their priority list,

    2) there are lots of people in the world that you can hire to manage a pension fund. There aren’t that many people who you can hire off the street to manage a national strategic investment fund.

    3) If you have a pension fund, the people that you hire to manage the fund don’t have to be Chinese, and there are good reasons to hire lots of non-Chinese. In you have a fund whose goal is strategic investment to advance Chinese national security interests, then the people you hire pretty much have to be Chinese, and that means that you can’t tap into global expertise, and you run into local political issues.

    4) the goals of managing a pension fund are pretty clear (keep old people from rioting), and so you have more investment discipline and fewer bureaucratic battles

    HZ: What CIC could do is to provide a transparent lower rate and stable debt financing to companies engaged in agriculture, mining and energy industries. As only a debt investor, it would disavow of control of where the end products should go.

    That’s actually what China Development Bank was supposed to do, but CDB hates this job because by having low interest loans, CDB doesn’t make any money and gets saddled with bad loans it doesn’t want. I wouldn’t be surprised if in the next five years, the PRC forms a development bank which combines the Agricultural Development Bank and some other institutions. However, that will involve looking over CIC’s track record and it’s mistakes.

    One step at a time…

  • Posted by don

    Twofish:

    Those are neat points. But I wonder. Would China have the same trade surplus without official exchange intervention? I can’t help but believe that they would have a smaller surplus and lower income growth, perhaps more in line with spending growth. Which would mean lower saving.

    After all, the intervention implies that the exchange rate is being kept below its market equilibrium, and the surplus would presumably be smaller with a dearer yuan.

    I know that the debate over the efficacy of currency intervention is not settled, and that people in Japan’s central bank secretly snickered at attempts by the Finance Ministry to keep the yen down by intervention. However, I doubt if the yen carry trade would have been quite so strident without the belief that the Finance Ministry stood ready to prevent a too rapid appreciation of the yen.

  • Posted by HZ

    2fish,

    Chinese pension funds should act very differently from US ones. First let’s be clear that domestic pension investing (assuming total savings/investing is unaffected) merely changes how the gdp pie is/will be sliced. The same thing could be done through fiscal policies. (This is why it makes no sense to privatize Social Security in the US, assuming people deem it a worthwhile thing to have. SS fund is just an accounting entity.) Now in the US we have low personal saving rate so pension investing provides a source of long term capital. Secondly there are many qualified investment professionals that can do at least a decent capital allocation job so that helps the economy as well. Neither is true in China. China has high savings (large C/A surplus) and further domestic pension investing just drives up asset price and lowers ROC. Bad and nontransparent pension investments (the Shanghai example you gave) also mis-allocate resources and hurt the economy. And domestic financial investing doesn’t do anything to address the future problem of a upside down pyramid in the demographic structure. If they have problem doing indexing they could hire Vanguard/Fidelity, who could do it at under 0.1% annual cost. The goal should be to buy a slice of world GDP, so you could just invest through the total equity and bond market index (ex-China, of course). Yes it may drive up the asset price overseas a little bit but that is OK as long as ROC is higher outside of China than inside China. Inside China the urgent thing to do is to develop the capital market so as to move government and state banks further from capital allocation and give private enterprises easier access to both equity and debt capital.

    CIC is certainly acting as a strategic investor not a financial investor. Why should it be the one to re-capitalize the agriculture bank? Since it is funded with debt, it should mostly invest in debt as well. If it acts in a transparent manner to strategic industries outside of China a lot of the bad loan problems will go away. Suppose it provides companies like BHP with low cost project funding, then hurdle rate of RoA could go down and still give BHP a decent RoE. This will then create more supply at lower cost. If it teams up with qualified equity investors the risk is actually a lot smaller than doing equity investment itself. It achieves two goals: better return than ultra safe foreign government securities and more supplies of resources that China needs. The development bank idea is fine too if it has the same access to long term capital but the fund could potentially run more transparently than a bank? Or best of all, open up the capital market to foreign companies so that they can raise capital directly in the Chinese public market (without intermediaries like CDB or CIC) — MoF may need to provide some form of Fx insurance, though it could restrict the Fx risk subsidy to the strategic industries.

  • Posted by HZ

    Brad,

    http://www.nytimes.com/2008/04/30/business/worldbusiness/30yuan.html?ref=business

    Exchange rate adjustment does work. However a one step reval or a faster appreciation could have bankrupted many worthy producers. People needed some time to adapt esp after many years of selling in USD with a pegged RMB.

  • Posted by RealThink

    @Brad

    "For all the calls to adopt a coordinated response that guarantees that exporters won’t take steps — like taxing exports — that hurt the importers as well discouraging increased production in the exporting economy, my guess is that the food crisis will produce more government intervention in the market, not less."

    That can be shown by a simple model which takes into account that, as export restrictions (by quotas or tariffs) cap the price payed to the producer thus reducing his profitability, some marginal land remains unprofitable to farm.

    The typical scenarios for a grain exporting country would be:

    A) With export restrictions:

    Production = 100

    Internal consumption = 80

    Exports = 20

    B) Without export restrictions:

    Production = 120

    Internal consumption = 60

    Exports = 60

    Clearly all exporting countries will go along path A). Food importers beware.

  • Posted by Qingdao

    two quick points: Yasheng Huang has a summary of his new book at "mit sloan school working paper 4699-08;"

    and David Dollar went to iie and met with the "pessimists" and concluded "the risks on the downside were more serious than I had thought;" from this he concludes: "…clever planning was even more urgent." Finally, Kuijs adds that he remains "cautiously optimistic."

  • Posted by Qingdao

    2 Fish: I think you have given yourself two impossible tasks: defending the ccp and educating dc.

  • Posted by Anonymous

    HZ: It is become more interesting, do you implied that by having a portion of CIC or new entity fund to invest in global market (at least alleviate some of china domestic pension fund burden/aging problem) means rather than have a "MAD" it is better of having Mutually Assured Prosperity?

    Two fish: From the lenses of existence (ie China built the great wall long time ago) yes CIC is better a strategic investor

  • Posted by DC

    A New World Order in Global Banking. . .

    Three Chinese Banks now the World’s Largest with Western Banks suffering from US Mortgage Collapse

    http://afp.google.com/article/ALeqM5iBo7t1tdnq1FDBnfWXMn1FXVH8qg

    PARIS (AFP) — Three Chinese institutions were among the world’s top four banks at the end of 2007 at a time when the market capitalisation of Western banks was suffering from a global financial crisis, a study showed Wednesday.

    The number one spot in the rankings, compiled by the Boston Consulting Group, was occupied by the Industrial and Commercial Bank of China, with market capitalisation of nearly 340 billion dollars (218 billion euros).

    In second place was China Construction Bank, followed by HSBC of Britain, Bank of China, Bank of America and Citigroup of the United States.

    The study found that banks in North America and Western Europe had suffered a loss of 695 billion dollars in market capitalisation at the end of 2007 while their counterparts in emerging market countries Brazil, Russia, China and India had seen their market capitalisation increase by 753 billion dollars.

  • Posted by Guest

    "…In today’s China, government is decentralized, and people can freely start businesses, find new jobs, move to new homes. After a century of powerful leaders and political turmoil, Chinese history has become the story of average citizens.

    But there are risks when a nation depends on the individual dreams of 1.3 billion people rather than a coherent political system with clear rule of law. China faces an environmental crisis… The gap between rich and poor has become dangerously wide… Each of these problems is far too broad to be solved, or even grasped, by the average citizen. And because the government continues to severely restrict political freedom, people are accustomed to avoiding such issues. My students taught me that everything was personal—history, politics, foreign relations—but this approach creates boundaries as well as connections. For many Chinese, if a problem doesn’t affect them personally, it might as well not exist…" http://ngm.nationalgeographic.com/2008/05/china/journey/hessler-text

    "…45 percent of Chinese urban residents are at health risk due to stress, with the highest rates among high school students… In China, there is no concept of the rebellious teenager. Across Chinese society, parents appear completely at sea when it comes to raising their children… She intends to marry a foreigner because they are richer and more reliable… Some observers of Chinese society look at children like Bella and see political change: Her generation of individualists, they predict, will one day demand a say in how they are governed. But the reality is complicated. Raised and educated within the system, they are just as likely to find ways to accommodate themselves to it, as they have done all along…" http://ngm.nationalgeographic.com/2008/05/china/middle-class/leslie-chang-text

  • Posted by DC

    Oh please, CIA Director Michael Hayden still doesn’t get it. It really doesn’t matter what the Washington Consensus thinks anymore. The US can barely take care of its own domestic problems and issues. Bye-Bye US Global Hegemony. Hello, new multi-polar world order. – DC

    China Threat to be focus of U.S. attention in Asia: CIA Director Michael Hayden

    http://www.reuters.com/article/topNews/idUSN3055603720080430

    "China, a communist-led, nuclear state that aspires to — and will likely achieve — great power status during this century, will be the focus of U.S. attention (in Asia)," CIA Director Michael Hayden said. China is an economic and strategic competitor with the United States, Hayden said in a Kansas speech on 21st-century trends, adding the country was likely to continue a "troubling" military buildup.

  • Posted by DC

    US Central Intelligence Agency program to Balkanize China

    http://onlinejournal.com/artman/publish/article_3156.shtml

    US CIA even financed a $245,000 investment to the University of Hawaii to research whether the tense situations in ethnic areas of China would lead to a split of the country. Actually, the research results disappointed their aim. America has been continuously backing the independent movement of Tibet all along. A movie "Seven Years in Tibet" produced by U.S. fooled the American with distorted historical facts. Funding was poured into foundations in U.S. to continue the anti-Chinese activities.

    “Humanitarian Interventionists and Benevolent Global Hegemonists, most of whom lack even a rudimentary understanding of China’s long and complex history, share a particularly nasty trait. Many of these Globocops imagine because they have downloaded a few pages of separatist propaganda from tibet.org, and shed a tear or two while watching ‘Seven Years in Tibet,’ that qualifies them as China experts. They believe this qualifies them to pass judgment about whether China ‘deserves’ to remain intact or be forcibly Balkanized by the World’s Only Remaining Superpower. Their attitude rivals that of the most contemptible 19th century imperialists.”

    The CIA-attempted Balkanization of China has already come with its own blowback of anger at the US from China. And, whatever you think of China, remember we owe them nearly $300 billion in loans. They lent us the money for Bush’s recent rebate. Bottom line, it’s pointless that the US and other Western nations keeps creating impressions that the Chinese are hitting on Tibetans, when in fact recent the recent video from China showed just the opposite, Tibetans in their region attacking Han Chinese who live there.

  • Posted by DC

    Chinese GDP to overtake US Economy by 2015 – Economist Angus Maddison

    http://money.cnn.com/2008/04/29/magazines/fortune/seven_years_learn_chinese.fortune/index.htm?postversion=2008043005

    A recent study by the economist Angus Maddison projects that China will become the world’s dominant economic superpower much sooner than expected – not in 2050, but in 2015. Angus Maddison’s forecast (which uses purchasing power parity) isn’t built on outlandish assumptions. He assumes China’s growth will slow way down year by year, and America’s will average about 2.6% annually, which seems reasonable. But because China has grown so stupendously during the past decade, it should still be able to take the crown in just seven more years. The world’s largest economy until 1890 was China’s. That’s why Maddison says he expects China to "resume its natural role as the world’s largest economy by 2015." That scenario makes sense. Then the Industrial Revolution sent the West on a more prosperous path. Now the world is returning to a common economy, this time technology- and information-based, so once again population triumphs.

  • Posted by Twofish

    don: Those are neat points. But I wonder. Would China have the same trade surplus without official exchange intervention? I can’t help but believe that they would have a smaller surplus and lower income growth, perhaps more in line with spending growth. Which would mean lower saving.

    Most of Chinese income and growth comes from domestic sources. The trade surplus is a politically hot topic in the United Staes, but it’s not the main source of Chinese economic growth. The roots of Chinese saving started during the central planning era when money wasn’t useful so people saved lots of it.

  • Posted by Twofish

    HZ: First let’s be clear that domestic pension investing (assuming total savings/investing is unaffected) merely changes how the gdp pie is/will be sliced. The same thing could be done through fiscal policies.

    If you do it view fiscal policies then you get into the very messy world of public finance. One is also constrained by the fact that the pension liabilities have already been promised, and you really can’t change the benefit structure without having riots. Also, one problem with aggregate numbers is that it misses the question of "who gets what?" Brad’s point that the policies of the Chinese government might reduce total return for the Chinese economy is valid, but it misses the "who gets what?" question.

    This is an important blind spot since a lot of economic theory is based on the premise that organizing an economy in a certain way will boost efficiency and increase total output and that is a good thing. It is, but if you boost efficiency and people don’t get that extra output, you might find yourself in trouble.

    HZ: CIC is certainly acting as a strategic investor not a financial investor. Why should it be the one to re-capitalize the agriculture bank? Since it is funded with debt, it should mostly invest in debt as well.

    CIC shouldn’t re-capitalize ABC. Also CIC is funded with debt, but those debts are now on the balance sheet of the Chinese government and not on CIC’s balance sheet.

    HZ: Suppose it provides companies like BHP with low cost project funding, then hurdle rate of RoA could go down and still give BHP a decent RoE. This will then create more supply at lower cost.

    Which is useless to CIC, if it can’t get any of that extra funds, and it’s useless to the Chinese government if it can’t access any of the productivity boost via taxation. Also decreasing the cost of raw materials might be a bad thing. The problem from a public administration point of view, is that what *will* happen is that BHP will collude with CIC to provide low cost loans which will boost BHP’s profits. This may not be a good thing. Also "transparency" isn’t going to solve the problem. I know that California farmers are given access to water at below market rates, and I know that Chinese SOE’s are also given preferential treatment by banks. Now what?

    The way CIC does it is that if CIC gives away loans at low interest, then there is less money to pay bonuses at the end of the year. The investor wants to maximize returns on loans. The borrower wants to minimize it. You get a balance. If the lender has incentives to reduce the interest rate, then the lender and borrower will collude to give away free money. This is generally a bad thing.

    People have these strange ideas about "transparency" missing that large parts of the financial system are intentionally opaque. Would you do business with a bank that made your checking account transactions public?

  • Posted by Twofish

    I don’t think that it is a good thing that Chinese banks are the world’s largest by market capitalization. Most of the banks that were the world’s largest by market capitalization in 1990 were Japanese. High market capitalizations usually means that the market is overvalued.

    Also, I don’t think that the dangerous people are in the CIA now. The CIA fought hard against the Iraq war, and the Bush administration had to bypass and vilify the CIA to get the Iraq war started. The danger in focusing on the CIA is that you miss where the danger comes from. The CIA stopped being used for most covert operations in the 1970′s with the Church Commission, and then it moved to the NSA. Once people started looking at the NSA, it moved elsewhere.

    Finally, I don’t think very highly of Yasheng Huang’s ideas. He sees everything in terms of a "transitional economy" which I think is bad framework. Also he talks about the golden age of the 1980′s when rural industries had access to large amounts of capital and neglects to mention that this age ended in the early-1990′s when the rural financial institutions went broke.

  • Posted by HZ

    2fish,

    While your criticisms are valid, what I suggested may still be the least bad alternative. Alternatives are limited in the first place:

    1) If they want to be an active financial investor in the public market, well the game is zero sum. For some to make above market returns others must make below market returns. Taking into account of the size of investment pool, high cost structure of active management and the risk their managers might expose them to, I don’t see this as attractive. Pension funds could do passive investing and count on returns in decades, not years.

    2) If they want to PE or strategic acquisition they will run into a lot of resistance in the West.

    3) If they want to do greenfield — well, CIC doesn’t have the expertise.

    So they might as well set a moderate goal. They did say that they will be doing mostly corporate debts, didn’t they? Tilting it towards increasing supply of commodities that China will surely need doesn’t sound too bad a policy either. If BHP makes more profit, so be it. If they set a moderate goal, they could still set up the incentive structure so that good performance is rewarded and bad performance penalized on the managers’ part.

  • Posted by Twofish

    HZ: If they want to be an active financial investor in the public market, well the game is zero sum. For some to make above market returns others must make below market returns.

    The efficient market theory argues that for any given risk level there is given rate of return and you can’t boost return without boost return, Making the expected return for a given level of risk is a hard thing to do. My point is that above $50 billion, passive investing is impossible.

    HZ: If BHP makes more profit, so be it. If they set a moderate goal, they could still set up the incentive structure so that good performance is rewarded and bad performance penalized on the managers’ part.

    The trouble with that structure is that CIC managers have no control over decisions that BHP makes. If CIC loans money or is a supplier for BHP then what is good for BHP is bad for CIC, and vice versa, and so rewarding CIC mangers for BHP performance will cause problems.