Forget about the CIC. The state banks are the real story for now
Rose Yu and Amy Or’s Wall Street Journal story on China’s reduced appetite for Agency bonds is loaded with interesting detail. And not just about the fall in Chinese state banks’ holdings of Agencies.
The fact that the Chinese state banks only held $23 billion or so of the $463 billion* or so of Agency bonds that China holds, according to the US data, confirms what I suspect was more or less known: the State Administration of Foreign Exchange holds the lion’s share of China’s Agency bonds. Remember too that the US data almost certainly understates China’s true holdings of Agencies.
Two other details in the story were more interesting, at least to me:
One: The big state commercial banks have $459 billion in “overseas” assets. That is way more than the CIC.
“China’s banks have significant overseas funds to deploy. Bank of China had $240 billion of overseas assets at the end of June, while the other three big lenders had a combined total of $219 billion.”
That sum exceeds the foreign exchange reserves of all but three central banks (China, Japan and Russia) and (in all probability) all but one sovereign wealth fund (ADIA). The state banks foreign portfolio is way larger than the CIC’s external portfolio.** Though, given that the CIC formally owns the state banks, it may well make more sense to add the state banks’ $460 billion or so to the $100 billion held by the CIC. That would imply that the CIC already could give ADIA a run for its money — as recent statements by the al-Nahyan family suggest ADIA doesn’t have the $800 billion commonly claimed.
Two: China’s state banks haven’t exactly been a stabilizing presence in global markets over the past year.
To be honest, I haven’t quite worked out how all the different data sources (the information the state banks disclose to their shareholders, the BoP data and the PBoC data) add up. China’s NIIP data suggests that Chinese investors held $240 billion in external assets — and most of that is debt. Most of that comes from the state banks, but it also leaves out around $250 billion of the state bank’s total foreign assets.
Setting that caution aside, Both China’s balance of payment data and the PBoC’s data on the state banks tell a similar story.
The PBoC data indicates that the state banks were big buyers of foreign debt (portfolio investment) from late 2005 to the middle of 2007 — and then turned into big sellers. Their holdings peaked at above $195 billion in the second quarter of 2007. Data on the PBoC’s mandarin site indicates that they subsequently have fallen to under $145 billion – even as the line items that I think correspond with the bank recapitalization and the state banks’ swaps with the PBoC have continued to grow.
That fall is consistent with the Chinese balance of payments data, which shows $13b of sales of foreign debt in 2007 — after over $100 billion of purchases in 2006. Sales of $23 billion in the second half of 2007 topped purchases of $10 billion in the first half of 2007 (no data is available yet for h1 2008). It also matches up with the US data. The evidence that Chinese state banks have been scaling back their holdings of risky assets is overwhelming. First “subprime.” And now Agencies.
That leaves the question of how exactly the state banks have been investing the influx of funds from their new dollar reserve requirement unanswered. The reserve requirement really got ratcheted up just when the state banks’ recorded holdings of foreign debt really started to fall. I don’t think the “funding” line items above correspond with the dollar reserve requirement — as they have a long prior life. I certainly don’t know, but it also isn’t inconceivable to me that the PBoC invests the state banks dollar reserves given that they seem to be listed as “foreign assets” on the PBoC’s balance sheet.
China is now a bit like Abu Dhabi. They are a lot different pools of foreign exchange floating around, but all are controlled in one way or another by the state.
The debt sales of China’s state banks call into question all the talk about how sovereign investors in general and sovereign funds in particular have been a stabilizing presence in global markets.
Whenever I read such a claim (for example, this Reuters’ article on the SWF’s new set of good practices, claims “During the current financial turmoil, which began in the U.S. housing market, wealth funds have proven to be market stabilizers”), I wonder how exactly anyone could know how sovereign investors — counting state banks and central bank reserve managers as well as the wealth funds — have impacted the market.
After all, there is no aggregate data available on sovereign funds total portfolio. And I don’t think the publicly available data is strong enough to support any strong claims about the overall impact of sovereign investors on the market.
We know that sovereign funds have injected money into US and European banks and broker-dealers. And each dollar of bank equity is leveraged up, so it supports a larger portfolio. The new capital injections have limited the extent to which banks have had to scale bank their balance sheets to match their scaled-back capital. That is stabilizing. Absent these investments, there likely would be even more distress in credit markets than there is.
But sovereign investors — paced by the Chinese state banks, who are owned by a sovereign fund and manage external assets for that sovereign fund and the central bank — also seem to have lost their appetite for most risky assets. Total net foreign purchases of US equities are down over the last 12 months. Chinese state bank’s have stopped buying certain types of US debt. More recently central banks have shied away from the Agency market.
That by contrast isn’t stabilizing.
The latest BIS banking data suggests that private banks are fleeing risk and stocking up on government bonds. State banks can not really be criticized for acting like private bank and reducing their exposure to risk assets. At the same time they can hardly be lauded for using their deep pockets to stabilize the market. Right now there is no shortage of demand for Treasuries, while riskier forms of debt are available at a nice discount …
Assessing the overall impact of sovereign investors on the market, in my view, requires data that the sovereign funds — and key central banks — haven’t been willing to release. There are, after all, persistent rumors that state investors have been large players in the “paper” commodity market.
So what are China’s state banks doing with the money they aren’t using to buy US securities?
Yu and Or suggests that they are increasingly looking to lend to Chinese state firms seeking to expand abroad.
Syndicated lending is one of the few bright spots in the banking business, analysts said, in part because borrowers have shied away from issuing debt in the face of higher yields. Using more of their overseas funds for corporate lending would help build Chinese banks’ international experience. “Given the fact that a lot of Chinese companies are seeking overseas expansion, it’s a good opportunity for cash-rich big Chinese banks to develop a syndicated-loan business,” said She Minhua, a banking analyst at China Securities Co.
The magnitudes involved are still rather small — and probably too small to account for the full gap between the state banks’ reported foreign assets and the reported foreign portfolio holdings of Chinese investors other than the central bank.
But they easily could grow. I at least have a hard time seeing how Chinese state banks’ current ability to borrow foreign exchange from China’s central bank to lend to Chinese state firms looking to expand abroad quite fits into a story where the state pulls back from the commanding heights of the global economy.
The Chinese state’s efforts to support Chinese exports by holding the CNY down have effectively made large sums of foreign exchange available to Chinese state firms looking to expand abroad. Reserve growth has helped to fuel the outward expansion of state capitalism.
That, in some sense, is a bit of a surprise. Ten years ago few expected that in the twenty-first century private banks would be cash-constrained and state banks cash-rich. And that the way states invest would matter to more markets than ever before.
* This sum includes China’s likely holdings of short-term Agencies. China’s long-term Agency portfolio, according to the US data, was around $446 billion at the end of June.
**The CIC, incidentally, doesn’t seem to have made large external equity investments yet; this SWF radar report suggests that the process has only started
“China’s state banks haven’t exactly been a stabilizing presence in global markets over the past year.” – Brad Setser
Let’s get the record straight. Wall Street banks peddled their AAA-rated Subprime garbage to foreign investors looking for investment safety. Wall Street has destabilized world financial markets by fraudulently misrepresenting securities. As per Bloomberg, the Bank of China was stuck with a $9.7 billion financial loss on AA and AAA rated Subprime bonds. It should not be surprising that the Bank of China is fearful of financial losses on GSE paper. Even looking to lend to Chinese state firms seeking to expand abroad appears to be increasingly less risky.
http://www.bloomberg.com/apps/news?pid=20601080&sid=aJJl4PDrAGpo&refer=asia
1. One thing is clear from recent financial market turmoil: During the down time, banks are social liabilities. No matter what they are, private banks or state banks, government has no choice but bail them out if they get into trouble. Ownership structure(private/state owned) has nothing to do with performance/holding assets.
2. The observations that US banks are cash strained and China banks are cash rich are static ones. This recession is a dynamic and prolong one. Most conclusions in the middle of the process will look naive at the end. It is a safe bet that China economy will have a slowdown and banks will have rising NPLs so cash will be desperately needed in the future. At the macro level, the surplus will be necessary once the aging problems become more obvious. (see Michael Pettis’s blog).
3. When you talk about stablization, I hope you do not mean “we should take your loss and you can cheat us with dubious SIVs”. Nobody on the earth will do that, at least without some payoff. Cheat me once – shame on you! Cheat me twice – shame on me! If SWF does not naked short selling you, you should feel lucky since SWF is already much more stable than HF and IB.
4. A little bit OT. The mentality of blaming others is somehow annoying. Do not buy something you cannot afford. Greedy or stupid is not excuse.
Fatbrick — I wasn’t trying to assign blame. Note the following line:
“State banks can not really be criticized for acting like private bank and reducing their exposure to risk assets. At the same time they can hardly be lauded for using their deep pockets to stabilize the market.”
My argument was with those who argue that sovereign investors are intrinsically stabilizing (and yes, that does mean buying what others don’t want … not buying what others do want) not with the state banks’ decision to cut back after taking losses.
The state banks were significant buyers of US debt in 2006, on the way up (there were over $100b in total “private” chinese debt purchases in 06 in the BoP data). They have been modest sellers since mid 2007 on the way down. That isn’t my opinion — it is what the PBoC data and China’s BoP data tells us.
Incidentally, I agree with your point that the state banks will see their NPLs rise as China’s economy slows. I think Pettis is right on this, even if I am not convinced that the scale of this implicit loss is so large that the chinese government has no room for a fiscal stimulus.
But I don’t think that is determinative for the banks access to external liquidity. If SAFE shifts $200b to the state banks out of its existing reserves, their dollar liquidity could go up even as rising NPLs cut into their domestic capital and they are less keen to expand domestically. The pool of fx the banks are drawing on is largely a function of China’s exchange rate policy and a policy decision to shift the management of some of that fx to the state banks.
DC — I suspect you are right that the risks of lending to a Chinese state firm are lower in a lot of ways than lending to a US bank, at least if you are a state bank lending to state firm pursuing an objective the government supports (i.e. a firm like Chinalco). That is what scares me …
The continued discussion about SWFs “stabilizing” roles is getting tired, isn’t it?
The real destabilization has come from New York and London banks that originated and sold opaque highly-leveraged assets whose costs are still coursing through the financial system.
Up until now, for the last few years I’ve been hearing Chinese officials say that they have a “frail” banking system, and that is the reason they have to re-val up slowly. This was attributed to massive over investment in industrial firms leading to far to much internal competition among companies and unsustainable operating margins.
So what ever happened to this story? I haven’t heard of massive consolidation of industry there as capitalism is wont to do.
So if the internal story has not changed, and external investment is on the rise, wouldn’t that mean more leverage against a questionable loan portfolio and less global “stability”. (I totally agree that Wall Street is not the model world citizen here).
We know in the past that recession are particularly hard on on heavily indebted industrial companies, so why wouldn’t we expect another Asian crisis, except with a bigger player than little ‘ole SE Asia?
“That is what scares me …”
I am not following you. If a China state firm with China bank srpport wants to buy something in US, US government can intervene at will, needless to say that blocking a deal is much easier than reaching a deal. And there were examples.
If China state firms want to buy into other regions of the world, flankly speaking first it is really not US’s business. Secondly, let’s assume that foreign governments are as competent as US government, thus they are qualified to make decision about their own economic policies.
About stability, I think it usually means that you invest in something long term viable and disregard the short term volatility. I never think that it means buying obvious worthless paper.
Why does state bank lending to a state firm like Chalco scare you? The balance sheets of Chalco are very transparent to all. In fact the equity shares of Chalco are even listed on the NYSE under the symbol ACH. Financial balance sheet statements for China Chalco Corporation are available at your fingertips.
Aluminum Corp of China (Chalco)
http://finance.yahoo.com/q/ks?s=ACH
It is really quite absurd to make the argument that China Chalco is less transparent than privately held Chrysler corporation which doesn’t issue any public financial statements. The privately held Chrysler Corp is lobbying for a $50 billion loan guarantee program from the US government. The opaque highly-leveraged assets originate from Wall Street private equity and hedge fund firms rather than from China’s majority state-owned corporations that issue annual financial reports and hold shareholder meetings.
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The stabilization point is an important perspective that warrants repeating. My sense is that you’re making a factual observation as much as a normative judgement about the rather flimsy level of stabilization contribution. China’s financial behaviour in aggregate, with all of its banking tentacles, is not so much different than the case of the domestic situation faced by the Fed. Banking everywhere has become cyclically risk averse – too much so at this point. The problem is to get capital adequacy, credit and some threshold level of risk taking restarted in the wake of an enormous credit shock to the economy. The Fed has responded not only with lower rates but targeted programs to get credit moving again. The US and European banks, being capital constrained and naturally risk shy, are having trouble responding in kind and have tended to hoard cash instead – hence the LIBOR problem. China’s reluctance to expand its risk profile at this stage is a compounding factor at the global level – for imbalances in terms of risk distribution as well as country magnitudes. The problem was magnified from the outset given the extremely risk averse portfolio China had already accumulated by the time the credit crisis hit.
JKH — exactly.
China had a very risk adverse (at least credit risk adverse portfolio — it has a ton of currency risk) going into the crisis, in aggregate. but at the margin it started to take on more risk in 06 and the first part of 07. SAFE bought more agencies and fewer treasuries, and lots of agency pass-throughs. the state banks started to take on credit market risk. Now both are scaling back on their risk profile (which wasn’t large to begin with) when the private financial institutions that previously had taken on credit risk (acting as intermediaries) aren’t able or willing to do so. the combined pull back magnifies market dislocations. the capital SWFs have injected to the banks by contrast has helped limit the scale of deleveraging, but widening credit spreads by contrast cut into capital and increase the need to scale back.
fatbrick — I am uncomfortable with state capitalism generally, and state capitalism supported by non-democratic governments especially so. I suspect Chinese state firms will always prioritize Chinese jobs over profits (in the same way china’s XR regime prioritizes export jobs over the financial health of the central bank). But i agree that if a Chinese state bank finances a Chinese state firm investing in Africa, that is a matter for the two countries involved — not one where the uS has much cause to step in. Indeed, if chinese investment starts funding current account deficits in the emerging world, that would help facilitate us adjustment.
per my comment above, it isn’t China (really sovereign investors) or the street. it is China (SAFE and the state banks) AND the street. Both are broadly speaking acting in the same way (scaling back risk) and that is pushing down treasury yields and pushing up credit spreads.
The recent performance of UBS must have been extremely embarrassing for the Swiss…so this is how they respond. In another report it sounds like those numbered bank accounts that rich people and crooks use to hid money from the IRS are on the way out too.
But this is what we need for the long term, along with 20% down, fixed rate mortgages, less state capitalism for poor people in China, less State Socialism for rich people in the US, do away with 100:1 leveraged hedge funds, somehow make money as good as commodities again….etc.
But no doubt it would be recessionary.
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Swiss Bank Regulator Seeks Leverage Ratio Cap For UBS, CS
16/6/2008
11:17
[Save as Text File]
ZURICH -(Dow Jones)- Switzerland’s banking regulator is seeking talks with UBS AG (UBS) and Credit Suisse Group (CS) in the coming months to start further measures to clamp down on risk-taking, a spokesman said Monday.
The Swiss Federal Banking Commmission wants a cap on the leverage ratio – a measure of risk calculated with shareholder’s equity and a bank’s balance sheet sum – after massive losses on subprime and other mortgage securities, spokesman Tobias Lux said.
The move follows the regulator’s efforts to bolster capital and liquidity requirements. UBS has been particularly hard hit by the credit crunch, so far writing down over $37 billion in mortgage securities.
Though UBS and Credit Suisse don’t have leverage ratio limits, their U.S. counterparts do.
The spokesman emphasized the regulator will initially seek talks with the country’s two major banks, and gradually implement the measures over several years.
Most storms begin with clouds and move on to thunder with lighting and fianlly rain. This is thunder that the GSE are in serious trouble as people leave the equity markets for safer investment we get a vicious feedback loop that holdings go down, people sell, stocks/bonds go down further. China is leaving a fairly secure postition (the goverment back bonds) because they dont think it is safe as the return they are getting or that for whatever reason the US goverment will make good on its promise to back this bonds. Why? Cause we are approaching our limit of what we can borrow and a GSE bailout may drop the credit rating of the US. Making it more expensive to borrow money. This would be lighting.
What will the storm look like when it starts to rain. Bad I am afraid. Not sure where this train is going but I would buckle your seatbelts it is going to be rough.
Brad,
It’s really a laughable argument that China’s “very risk adverse” investments creates and magnifies market dislocations when the real problem is the gamut of very questionable business practices by Wall Street investment banks. In China, a 30% downpayment is required for any mortgage loan. The home mortgage lending business represents the safest portfolio line for state-owned Chinese banks. The AAA-rated subprime mortgage doesn’t exist in China.
In the United States, if you think the credit crisis is over, just wait till Alt-A and Option ARM bombs explode. Once again we see that all the chatter on CNBC bubblevision about “sub prime is over”, while true, does not encompass the full truth. What exotic financial instruments are resting on the Alt-A and pay option ARMs? What financial institutions are on the hook for issuing them? Too much financial risk and leverage has brought the US banking system to the edge of Armageddon.
DC — it isn’t either/ or
and china was buying (on a small scale) the output of those wall street firms in 06.
but my core point is — unlike say john lipsky of the fund — i don’t think you can square three things:
a) SWFS and state investors are bigger than every before
b) SWFs and state investors — per lipsky — tend to dampen volatility
c) the current state of the credit market (i.e. very wide spreads)
unless you note that swfs and central banks have tons of cash and haven’t been willing to take credit risk recently.
One thing that I’m curious about is what the count as a state bank. Most of the big Chinese banks have Hong Kong subsidiaries which have substantial amounts of private ownership. For example if Bank of China(HK) has $100 billion in assets, and is 60% owned by Bank of China, is that $60 billion in assets or $100 billion?
Once again, it is necessary to distinguish between MBS and corporate agencies. My understanding is that Chinese holders are mostly MBS, which would not lose a huge amount of value in case of a GSE default.
bsetser: I suspect you are right that the risks of lending to a Chinese state firm are lower in a lot of ways than lending to a US bank, at least if you are a state bank lending to state firm pursuing an objective the government supports (i.e. a firm like Chinalco). That is what scares me …
I’m not sure why that should be particularly scary. It’s not as if Chinese state banks are the only one’s investing in Chinese SOE’s. Alcoa has put as much money into Chinalco and the Rio Tinto deal as the banks.
Also Chinalco isn’t strictly speaking a state firm. The state holding company owned a third of the firm, but a third of the firm is publicly traded. Also, Chinese banks don’t favor state-owned firms. They favor large firms, which is a quite different bias.
I really don’t think that SWF’s actually do damped volatility. When push comes to shove, SWF’s act exactly like private firms, and they are avoiding the credit markets for the exact same reason that everyone is avoiding the credit markets.
I thought that having SWF’s act like private funds was supposed to be a good thing…..
Unlike the self-immolated Wall Street Investment banks, the SWFs and central banks have tons of cash precisely because they haven’t been willing to take credit risk. The Bank of China has written-off the $9.7 billion subprime bond loss. I’m sure hell will freeze over before Citicorp writes-off the $1.1 trillion “off-the-book” SIV containing subprime garbage.
bsetser: I suspect Chinese state firms will always prioritize Chinese jobs over profits
They actually don’t. As you have pointed out the industrial restructuring of Chinese corporations haven’t increased manufacturing jobs, and also while wages have increased, most the increase in GDP has gone into corporate earnings.
It is true that the Chinese government cares a lot about social stability, and they have a lot of carrots and sticks to force Chinese companies to keep jobs, but in this respect they don’t act very different from the US government.
When in comes to jobs and earnings, Chinese corporate managers basically act like American corporate managers….
I thought that was supposed to be a good thing.
Banking in the US has resembled Applied Quantum Physics more closely than prudent banking, in my opinion.
We have wave-particle duality, where individuals fly thru investment bank doors towards the public sector at the speed of light, make waves, then still behave as though they are individuals from investment banks.
Schrödinger’s equations indicate a range of probable credit ratings are possible on consumer and business loans, but has an uncanny way of collapsing on B minus, even though AAA was one of the possibilities.
Plank’s constant says the smallest unit of measure is one mortgage, but they are inseparably bundled together, so we are dealing with the aggregate bundle.
And there is the disturbing Schrödinger’s Cat thought experiment saying all bets are off on loan quality if statistical math can’t predict the extent of this potential jingle mail phenomenon which has been observed in real world. We just don’t know if the borrowers are alive or deadbeats.
Quantum entanglement has gummed up the works in the shadow banking system, where liabilities go off balance sheet and are separated in space-time, but their properties mysteriously stay linked and synched with the balance sheet they came from.
Now that the FBI is sniffing around in a “whodunit” investigation, I’m sure the Uncertainty Principal will come into play.
Dave C: Unlike the self-immolated Wall Street Investment banks, the SWFs and central banks have tons of cash precisely because they haven’t been willing to take credit risk.
No they have tons of cash for historical reasons, in that they were originally cashiers for the Chinese government. They also have cash because they don’t have anywhere to put their cash.
JKH: Banking everywhere has become cyclically risk averse – too much so at this point.
Banking has always been cyclically risk averse. When times are good, everyone is loaning money, eventually people get over extended, everyone cuts back, and that creates a feedback loop.
What the basic situation is is that SWF’s are just a set of new players, but the game remains the same.
Again, I thought this was supposed to be a good thing….
Regula: So what ever happened to this story? I haven’t heard of massive consolidation of industry there as capitalism is wont to do.
There has been massive consolidation of Chinese SOE’s. The Chinese government has basically been moving to turn what was once 15000 or so SOE’s down to about 150-200. There is a bias in bank lending toward big firms because credit risk is considered to be much less.
OK. I hadn’t heard that yet.
I’m still remembering a couple year old GavKal newsletter stating that there are 300 ball bearing manufacturers in China, which clearly sounds like too many.
Twofish,
Wall Street was the biggest credit bubble in history. Despite some financial losses, the Chinese banks were always peripheral to the credit orgy party.
Dave C: Wall Street was the biggest credit bubble in history. Despite some financial losses, the Chinese banks were always peripheral to the credit orgy party.
No they weren’t. They supplied the alcohol. The US credit bubble would not have gotten nearly as big as it had without the supply of funding from China and the Middle East.
That’s why Wall Street firms are so overwhelming pro-China.
2fish:
Agreed, that’s the whole picture.
Twofish,
Wrong. Under reckless Federal Reserve regulation, the fractional banking system that turns a $2 deposit into $100 of lending is responsible for the US Credit bubble. And every US dollar in the Chinese banking system was originally printed by the Federal Reserve. The Chinese didn’t counterfeit the trillions of US dollars in foreign reserves. The elixir of lax financial regulation and a “cheap money” monetary policy created the US financial fiasco. Negative inflation adjusted interest rates inflate credit bubbles. The current 2% discount rate punishes savers with a negative “real” rate of return on money with even the official inflation rate registering at 5.6% in the most recent quarter. Fed policy is grossly unfair to savers.
From the Wall Street Journal, China has had enough. China’s largest banks and other overseas investors have pared back their holdings in debt related to Fannie Mae and Freddie Mac.
http://online.wsj.com/article/SB122037859304991457.html
Chinese banks said they had trimmed their Fannie and Freddie portfolios since June. Bank of China Ltd., by far the largest holder of Fannie and Freddie securities among the four big banks, said it had sold or allowed to mature $4.6 billion of the $17.3 billion it held as of June 30 — which was down from more than $20 billion at the end of last year.
China Construction Bank Corp. said it had cut its Fannie and Freddie holdings to just above $2 billion by the end of July, down from $3.2 billion a month earlier. Bank of Communications Co. sold all of its $27 million in holdings in early July. Industrial & Commercial Bank of China Ltd., the country’s biggest lender, said it held $2.7 billion worth of Fannie- and Freddie-related debt at the end of June, but didn’t provide a comparison with previous months.
DC — the WSJ article you linked to was the article that I based my post on … just noting that for the record.
2fish — State firms have a tool of Chinese indsutrial policy and a tool of chinese social policy and a tool for financial market development (through listing) and a host of other things. The priority placed on each goal has changed over time. Social stability got downgraded in favor of profitability (or at least fewer losses) in the late 90s, but the state firms remained a tool for industrial policy (with a bit too strong a bias toward capital intensive development for my taste). All that said, i cannot see a Chinese state aviation manufacturer basing production in the US rather than China even if that made economic and financial sense. Maybe it is a lack of imagination on my part tho.
Incidentally, Chinese banks lending to chinalco (per mcgregor) for the rio bid provided more funds than the (small) alcoa contribution.
Actually it was all major central banks that acted in concert beginning in 2003 to “re-flate” the world economy. I’ve always thought inflating things is very bad, and now I see the results in real time, rather than reading about it in one of those “fall of civilization” history books.
But we did get the housing bubble growing and sent our counterfeited home equity to China via Wal-Mart and Home Depot.
We also ran a big fiscal deficit since supply-siders told Bush he could spend all the money he wants and still grow the deficit shut.
China responded by sending it back in to GSE’s and Treasuries and the party went on.
China could have spent it internally…plenty of things to do that the private sector doesn’t like doing, like solve the pollution problem, make workers feel better by setting up a national pension plan, etc….
But they decided it was better to peg and invest in the US.
One of the things easy money was supposed to do was increase business investment in the US and create jobs in a real economy. Outside of homebuilders and retail, there was little business investment. Probably because they didn’t see adequate returns even with the low hurdle of cheap money.
And the whole scenario for small savers and investors is they are playing in a casino, and the low risk parking lot is now occupied by central banks and large private institutions.
And yes, I think it all sucks.
Brad,
The US also utilizes industrial policy for the defense sector and commercial government sector. For instance, Airbus civilian A330 freighter production in the US will be col-located with military tanker production. Based on the French TGV, Amtrak Acela trainsets were assembled in Vermont. Given economies of scale, it would have been cheaper for the US government to buy made-in-France trainsets. And finally, commercial ships transiting from Alaska and Hawaii to the continental US are required to be manufactured in America. The Philadelphia Shipyard produces oil tankers and containerships at twice the cost of Chinese shipyards to meet the made-in-USA federal requirements for domestic ships. The reason for the commercial ship requirement is to preserve an US industrial base.
bsetser: State firms have a tool of Chinese industrial policy and a tool of Chinese social policy and a tool for financial market development (through listing) and a host of other things.
The Chinese government certainly thinks a strong industrial sector is good for China, but in order to have a strong industrial sector you need industrial firms that have a large degree of management authority and don’t exist merely to state policy because the modern economies are just too complex to be centrally planned. Once you give state firms some autonomy, then they start developing interests that diverge from those of the State Council.
bsetser: All that said, i cannot see a Chinese state aviation manufacturer basing production in the US rather than China even if that made economic and financial sense.
I suspect that Chinese aviation companies would love to buy stakes in Boeing’s factories, since it means access to US technology and skilled labor. I suspect that it won’t happen because the US government would veto it rather than the Chinese government.
DC: And every US dollar in the Chinese banking system was originally printed by the Federal Reserve. The Chinese didn’t counterfeit the trillions of US dollars in foreign reserves.
But it did buy then at extremely an extremely cheap price. Right now if the US financial system blows up (which I think is highly unlikely), it’s going to take China down with it.
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Twofish 2:27
I agree. But I said “too much so”.
Brad
could this mark a shift in holdings and therefore an indirect shift in ideology where power concentrated in the centre is being disseminated in different directions, paving the way for transition to modern market economies? of course that’s an optimistic reading .
one tool that state government still has in way of propaganda is to appeal to the idea that what is good for the nation as a whole is ultimately what is good for the individual unit. Not that cracks haven’t appeared in that type of logic. With that kind of mindset, you could theoretically convince people that setting up manufacturing in a foreign country is somehow beneficial to the nation, state and therefore the people. As long as suspicion doesn’t arise that profits are siphoned off in the direction of some bureaucrat’s pocket.Shared wealth as embodied by the treasury, central bank and SWF is still appealing to those who think big is beautiful
Yeo: one tool that state government still has in way of propaganda is to appeal to the idea that what is good for the nation as a whole is ultimately what is good for the individual unit.
Outside of times of war or crisis, this usually doesn’t
work very well. The problem is that it usually becomes obvious
very quickly that the people making the propaganda are
disproportionately benefiting from the system.
What China has done is to reverse the equation, what is good
for the individual is good for the state. So get rich and
make as much money as you can, and the nation will benefit.
One benefit to the state is that most people are too busy
trying to get rich and more often than not succeeding so they the
energy they put into making money doesn’t get directed at
demonstrating against the government. This is why government
don’t like unemployed people. Too many people with time on
their hands.
Yeo: With that kind of mindset, you could theoretically convince people that setting up manufacturing in a foreign country is somehow beneficial to the nation, state and therefore the people. As long as suspicion doesn’t arise that profits are siphoned off in the direction of some bureaucrat’s pocket.
A better approach is to set things up so that when the bureaucrat
makes money, someone else makes money. People might be against
nasty, evil corporations making lots of money, until you point out
that they own stock in that corporation in which case making
lots of money is a good thing. That is why the Shanghai
stock market exists so that you have large parts of the
Chinese public that *wants* SOE’s to make huge amounts of
money.
Also, if you want to understand how political systems work, it doesn’t work to
look at things from the top level. You imagine yourself a
CEO of an SOE, try to figure out the pressures and interests taht the
person faces, and then this will cause you to figure out
the decisions that they make. It turns out that the pressures on]
a CEO of a SOE are more or less the same as the pressures
on a CEO of an American corporation.
@ Cedric Regula
Absolutely loved the applied quantum mechanics example.
@Twofish
Agreed that SWF are just new set of players – but they are the first to have armies! I mean bargaining power derived from the state and physical armies if some were so foolish. So now does the game remain same?
@ Dave C
Your position is rational position from Chinese bank perspective. In fact any bank in its position would have similar issues. But we need to understand that problems have two parties and responsibility of solution will also rest with two sides.
@ Twofish
SOE consolidation – Consolidation, in certain cases, aggravates the risk. So we cannot ignore it. Its always the guys whose money is on the line – they have to do due diligence.
@ Brad Setser
Brad – I am sure China will be agonising a lot over what DC calls a “raw-deal”. Now multiply into it the size of funds backing that conviction. That to me is potential disaster in waiting. If it comes at a Wrong time – global banking industry may be in a hole like Saddam.
@twofish
SOE whichever nation- are always tool in moments of distress. Barring some European countries, everywhere you have some influence or other.
I look at it this way – any over-extending beyond natural balance will create similar over-extension. (This reads like idiotically complicated – lets simplify). Unbalance begets unbalance.
World over manufactured goods for US, US over manufactured currency (money) for the World. The ingenuity of the system (one can call it fraud or innovation – bu I dont take sides on this one) created a cycle wherein world continued to manufacture goods (and services) and US continued to manufacture money. We just woken up to Hey-emperor-you’re naked situation. The story does not tell us if Emperor ran for his clothes or if people suddenly closed their eyes or whatever. But its going to be one heck of an embarrasment for all of us. Like hollywood says – “Coming Soon…”!
Thanks for amazing post series Brad.
Rahul
P.S. The system thinks 6+7 is not 13!
Chinese government Industrial policy to encourage High-technology Industry
http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/09/02/cnimagi102.xml
Animation giant once made plastic Christmas trees, writes Malcolm Moore in Hong Kong
Eight Commercial Tower, a dusty, grey building in an old Hong Kong warehouse district, is the headquarters of one of China’s most bizarre companies.
In the past decade, Imagi has switched from being the world’s largest plastic Christmas tree manufacturer into China’s answer to Pixar, the computer-generated animation studio.
In its previous incarnation, named Boto, it shipped more than six million trees a year and was a prime example of the Chinese manufacturing miracle.
Some 10,000 workers laboured at its plant in Shenzhen, turning out 400 different types of trees, including green, gold, frosted with snow, and sparkling with fibre-optic lights. Some had real pine cones while others rotated and counted down to New Year’s Eve before launching into Auld Lang Syne.
Now Imagi is a symbol of China’s transformation from a low-cost, low-skilled sweatshop into a powerful competitor in high-technology industries. The cost advantages of making toys, cigarette lighters and other knick-knacks can easily be replicated with 3-D movies, it appears.
Imagi’s remarkable conversion is only one of many on the Chinese mainland. BYD, the world’s second-largest battery maker, is now looking at building hybrid cars and has hired a team of Italian designers. Airbus is about to start manufacturing the A320 in Tianjin, Intel is making chips in Dalian, and Chinese companies are leading the way in renewable energy technology, especially photovoltaic panels.
The Communist Party is determined to move industry up the value chain, using a variety of incentives and punishments. China’s low-end manufacturers have found their tax rebates withdrawn, and complicated export duties imposed. Their raw material costs have spiralled and they are going out of business in their thousands.
“Move up or move out” said the front page headline of the state-owned China Daily’s business section yesterday,
“The process may seem painful,” the newspaper intoned, but “it can help the economy achieve a more balanced and therefore more sustainable growth in the long term”. At Eight Commercial Tower, the transformation is well under way.
[...] which were a close substitute for Treasurys, are no longer absorbed by foreign demand with ease [0]). Hence, I think the case for higher interest rates [1] and hence crowding out in response to [...]
When people usually take about “industrial policy” they usually think about the top-down decision making process that you saw in Japan in the 1980’s. I wouldn’t use the term “industrial policy” to characterize Chinese economic decision making since is far too chaotic and there are far too many interest groups for there really to be a “policy.”
For example…
DC: China’s low-end manufacturers have found their tax rebates withdrawn, and complicated export duties imposed.
The government just increased tax rebates for textiles since they were complaining. The model in which the government orders something and it is done just doesn’t fit China, and what actually happens is that you have a mess of conflicting interest groups interacting with each other.
The statement that the “Communist Party decides everything” is true but meaningless and very misleading since in implies a top-down decision making structure which isn’t how things work. All of the major economic actors and interest groups have representation within the Communist Party and so that it’s not a trivial to figure out what constitutes a “decision” by the Party.
Twofish,
If the Chinese government directly finances advanced microprocessor technology, it represents Industrial policy. LOL
A Chinese Challenge to Intel
Researchers have revealed details of China’s latest homegrown microprocessor.
http://www.technologyreview.com/printer_friendly_article.aspx?id=21322&channel=specialsections§ion=storage
In California last week, Chinese researchers unveiled details of a microprocessor. The chip, code-named Godson-3, was developed with government funding by more than 200 researchers at the Chinese Academy of Sciences’ Institute of Computing Technology (ICT). Engineers have added 200 additional instructions to Godson-3 to simulate an x86 chip, which allows Godson-3 to run more software, including the Windows operating system.
China is making a late entry into chip making, admits Zhiwei Xu, deputy director of ICT. “Twenty years ago in China, we didn’t support R&D for microprocessors,” he said during a presentation last week at the Hot Chips conference, in Palo Alto. “The decision makers and [Chinese] IT community have come to realize that CPUs [central processing units] are important.”
Tom Halfhill, an analyst at research firm In-Stat, says that the objective for China is to take control of the design and manufacture of vital technology. “Like America wants to be energy independent, China wants to be technology independent,” Halfhill says. “They don’t want to be dependent on outside countries for critical technologies like microprocessors, which are, nowadays, a fundamental commodity.” Federal laws also prohibit the export of state-of-the-art microprocessors from the United States to China, meaning that microchips shipped to China are usually a few generations behind the newest ones in the West.
“Federal laws also prohibit the export of state-of-the-art microprocessors from the United States to China, meaning that microchips shipped to China are usually a few generations behind the newest ones in the West.”
Intel is building an entire plant in China. I wonder what federal law says about that?
I think the shift in policy towards high tech will make China lust after Taiwan even more. In semiconductors there is a long history of basic technology patents that hamstring a newcomer’s entry into the market. The existing manufacturers negotiate broad trades of basic technology licenses between themselves, making it possible for engineers to designs things without running into basic patent infringement issues. Taiwan has been in the game much longer than China.
DC: If the Chinese government directly finances advanced microprocessor technology, it represents Industrial policy.
It’s funding it through universities or CAS which doesn’t make it that different from the type of university funding that the US does. Like the US, there isn’t that much in the way of top-down direction.
What is missing is the financing and management elements to commercialize anything that gets developed in the universities. That will come eventually.
Regula: Intel is building an entire plant in China. I wonder what federal law says about that?
Quite a bit. There are huge export restrictions on the type of equipment that Intel can bring into China.
Are we talking about what the bank benefits from investment activity or the managers. Sorry, rude comment..
2fish
not disputing your points, however, for all the politician talk about understanding what the ordinary citizen thinks, oh pulease!
as for getting everyone else’s hands “dirty”, sure, but when the profits start dropping off , suddenly, the fingers are all pointing at you know who
as for the unemployed, wonder how many of the olympic tourist crowd got to see the big crowds of unemployed milling around beijing’s old neighbourhoods or even occasionally around tiananmen square, protesting. that looks set to be some permanent feature of certain chinese cities soon, empty stomachs and bleak futures are fuel for rage
when the individual benefits without the state getting in on the action, or without somnehow returning some to society, he seems destined for trouble, how many of the rich (eg hurun report) have disappeared from the list and reappeared on court lists; really doubt if china has really altered the equation as you seem to think?
[...] any mark to market losses on Blackstone and Morgan Stanley. Or $200-300 billion if the CIC and the foreign assets China’s state banks (which the CIC owns) effectively manage for the CIC — as these are [...]