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If you only read one thing on China this fall …

by Brad Setser
November 26, 2008

Make sure it is the latest World Bank China Quarterly.

David Dollar, Louis Kuijs and their colleagues have outdone themselves – and in the process provided a clear assessment of the sources of China’s current slowdown and the risks that lie ahead. I won’t try to summarize the entire report. Read it. The whole thing. No summary can do it justice.

Here though are seven points that jumped out at me.

1. China was no workers’ paradise during the boom years.

GDP growth has been quite strong. But wages have fallen from around 50% of China’s GDP at the start of the decade to around 40% of GDP. That – not a high rate of household savings – is the main reason why consumption is a very low share of GDP (See Figure 15 of the World Bank Quarterly). If China’s workers had secured a bigger share of China’s output, they could be better off now even if China had grown somewhat less rapidly. There is good reason to think that a world where China subsidies US borrowing (and consumption) isn’t the best of all possible worlds. The fruits of the recent boom weren’t shared broadly in either the capital-exporting countries or the capital-importing countries.

2. China really is a manufacturing and investment driven economy.

Even when compared to Korea in 1990 or Japan in 1980, China stands out. Investment accounts for a large share of GDP than it ever did for the smaller Asian miracles and manufacturing accounts for a higher share of China’s GDP than it ever did in other Asian manufacturing economies (Figure 14). Given China’s size, it is pretty clear that China cannot continue to grow by investing ever more and manufacturing ever more. China ultimately has to produce for Chinese demand not world demand.

3. China’s current slowdown was made in China, not in the world.

Yes, growth in “light manufacturing” (toys, shoes and textiles) has slowed. But electronics and machinery exports are still doing very well – even if they don’t get the press (Figure 3). Or perhaps I should say were still doing well in the third quarter; must has changed recently. China’ problem this year is simple: labor intensive export sectors have slowed more than capital intensive export sectors. Overall though China’s real exports grew at a 10-15% y/y clip in 08 – far faster than the overall growth in world imports. China’s real export growth is forecast to outpace its real import growth in 2008 – which implies that net exports will still contribute positive to China’s GDP growth. True, the net exports won’t provide as much of a positive contribution as in 07, 06 or 05. But they are still adding to growth not subtracting from it.

Why then is China slowing so sharply? Simple, real estate investment has hit a wall. After growing at 20% y/y for a long time, real estate investment stalled – with a y/y growth rate of around 0% (Figure 5). That means that China is in turn producing more steel and cement than it needs, and producers of steel and cement are cutting back. That in turns hurts iron ore exporters …

This though is very much a result of China’s own policy choices. Rather than allowing the real exchange rate to appreciate back when China was truly booming (05-late 07/ early 08), China’s policy makers opted to rely on administrative curbs on credit growth. That left China more exposed to global slump in demand – as it kept exports up by limiting real appreciation even as it credit curbs limited the amount of froth in the real estate market back when China was booming and real interest rates were negative. China invested a lot in real estate, but it is no Dubai. But China’s policy makers still look to have slammed the brakes on a bit too hard. Rather than slowing gradually, real estate investment fell off a cliff (Figure 5).

4. There is more bad news ahead.

While real exports contributed positive to GDP growth in 2008, they won’t contribute in 09. The World Bank forecasts that for the first time in a long time, 2009 real import growth will exceed real export growth. In 2005, real exports grew about 10% faster than real imports (23.6% v 13.4%). Many economists remain – for reasons that to be honest elude me – reluctant to draw the obvious connection: the most likely explanation for China’s strong real export growth is the large depreciation the RMB in 2003 and 2004. That combined with administrative controls – which limited lending, investment and ultimately imports – to create China’s large current account surplus. Real export growth exceeded real import growth by 5 percentage points in 2006 and 2007 – and by 4 percentage points in 2008.

The positive contribution of net exports to GDP is forecast to end in 2009: real import growth will exceed real export growth by 3 percentage points.

That though doesn’t mean that China’s currency isn’t undervalued. China’s exports are forecast to grow faster than the world’s imports, meaning China’s global market share is still increasing (see Figure 2). And if 2008 and 2009 are taken together, China will still be drawing on the world for its growth: the drag from net exports in 09 will be smaller than the contribution from net exports in 08 (see Table 1)

I fully realize that China is appreciating quite significantly now in real terms – just global demand for China’s goods is falling (Figure 11). The tragedy is that this appreciation is coming now – not two or three years ago when domestic Chinese demand was booming and China didn’t need to draw on the rest of the world to sustain strong growth.

5. The fiscal stimulus is real, but modest. China’s fiscal balance is expected to swing from a 0.7% of GDP surplus in 07 to a 2.6% of GDP deficit in 09. That is a 3.3% of GDP swing. In 2009 alone, China’s deficit is forecast to rise by 2.2% of GDP. See Table 1. That shift is important and will help to support China’s growth– but it will likely lag the swing in the US fiscal deficit. Hopes that surplus countries will end doing more than deficit countries seem unlikely to be ratified.

6. The last thing anyone needs to worry about is fall in Chinese demand for US treasuries.

The Treasury market obviously isn’t worried – not it 10 year Treasury yields are under 3%. And there is little reason for the bond market to be worried if current trends continue.

The World Bank forecasts that China’s current account surplus will RISE not fall in 2009, going from an estimated $385 billion to $425 billion. How is that possible if real imports are forecast to grow faster than real exports? Easy – the terms of trade moved in China’s favor. The price of the raw materials China imports will fall faster than the value of China’s exports. China’s oil and iron bill will fall dramatically.

In macroeconomic terms, China’s fiscal stimulus will offset a fall in domestic investment leaving China’s current account (i.e. savings) surplus unchanged. The 2009 surplus is expected to be roughly the same share of China’s GDP (9%) as the 2008 surplus.

In dollar terms, the World Bank forecasts that China will add almost as much to its reserves in 2009 than in 2008. That is a bit misleading: the 2008 reserve growth number leaves out the funds shifted to the CIC (ballpark, $100b in 08) and the rise in the foreign exchange reserve requirement of the state banks (ballpark, another $100b). But it captures a basis truth. Even if a fall in hot money inflows means that China will be adding $500b rather than $700b to its foreign assets, its foreign assets will still be growing incredibly rapidly. China already has – counting its hidden reserves – well over a $2 trillion. It is now rapidly heading for $3 trillion.

In broad terms – if oil stays at its current levels – China will be the only large surplus country in the world, and it will essentially be financing a US deficit of roughly equal magnitude to China’s reserve growth. It makes everything plain to see.

7. The way China manages its reserves matters immensely for the world not just China

China shifted from buying Agencies to buying Treasuries in July. Others did too, but no one has quite the market impact of China. China doesn’t disclose what it is doing with its reserves, but the recent shift in Chinese demand isn’t really in doubt. The market knows it. The TIC data for August showed it. And the latest Fed data strongly suggest large ongoing migration from Agencies to Treasuries.

China now accounts for such a large share of the world’s reserves that it is hard to see how the FRBNY’s custodial data doesn’t reflect, at least in part, a shift in Chinese demand.

A key themes of this blog has been how the internal imbalances of China’s economy are a reflection of its undervalued exchange rate – and that China’s surplus has implications for the world. It has to be balanced by large deficits elsewhere. Another key theme has been that the Fed has been pushed to absorb risks that other central bank reserve managers now shun. Nothing illustrates this more clearly than the Agencies. Foreign central banks are scaling back their Agency holdings. The Fed is gearing up to buy. Big Time.

One last note: I am taking a few days off for Thanksgiving – I’ll be posting again next week.

91 Comments

  • Posted by ndk

    Hopes that surplus countries will end doing more than deficit countries seem unlikely to be ratified.

    This is key. Keynesian stimulus makes a stunning amount of sense in China and India right now, but it makes no sense here in America. Via a paper by Werner, classical, Keynesian, and post-Keynesian economics all support interest-rate based arguments for why fiscal stimulus can cause crowding out of private demand. The only problem with those arguments in Japan is that real interest rates fell from 4% to 1% from 1990 to 1998. We have the opposite situation, with real interest rates very low during the boom and rising rapidly now. I think our policy actions are disastrous.

    Chindia’s debt-to-GDP is vastly lower, around 60%, and they have plenty of room to maneuver. Here’s deeply hoping that Chindia gets religion, and soon.

  • Posted by Bill

    Nothing like a World Bank report for the holidays…

  • Posted by adiemuso

    Brad,

    before i forget, Happy Thanksgiving..take a good break if possible..think we have more to come before the New Year.

    Brad Setser: “Easy – the terms of trade moved in China’s favor. The price of the raw materials China imports will fall faster than the value of China’s exports. China’s oil and iron bill will fall dramatically.”

    Im not too confident if that will be the case for 2009,2010 and 2011.

    It is possible that the world might avert a deep protracted recession or even depresion and recover soon perhaps in late 2009 or early 2010.

    However, im not too sure if the current massive expansionary fiscal n monetary policies will have no effect on inflationary pressures in the future.

    I have not against the need for the steep cuts and loose monetary conditions under the current credit crisis and threats to the world economy.

    And if so, under that scenario, I am thinking about the probabilities of Oil and other Commodities prices to remain at low prices. Limited supplies, be it structural or cyclical, might not meet the insatiable demand of the reformative or expansionary fiscal spending globally.

  • Posted by Chidambaram

    The imperative of maintaining the unity of Han China will drive the direction of Chinese policy. The unity of Han China is critical to the continued rule of the Communist Party. United States sponsored regime change (also called a color revolution in geopolitics) is on in Thailand, a close ally of China. The Thai regime change follows on the heels of regime changes throughout the South Caucasus, and China is the next obvious target.
    I’m yet to evaluate the impact of Treasury buying on China’s unity, and any help/analysis/commentary on that would be much appreciated.

  • Posted by Movie Guy

    Off subject:

    Brad, what is your position on the CDS bailout?

    Should the U.S. Government provide funding to cover CDS positions?

    Are you willing to do a main post on this critical subject?

  • Posted by Must Be Ture

    That report looks just like our gov propaganda.

    China thinks “the food price pressure episode” (25% yoy) has come to an end. Don’t count on it. They can only feed their babies melamine for so long before the people revolt.

    China may want to build roads, but they are going to have to buy our food. They need to reform their agriculture to move ahead.

  • Posted by Euraussian

    Sorry to see these juvenile comments after such a thoughtful post by Brad.

    It takes a little time to read the report and if you are familiar with east asian development, much of what is going on in China will be familiar. A declining employment share is positive, given China’s socialist and featherbedding urban past. However, China is very big, and not as compact and (relatively) homogeneous as Korea (and no socialism there) , my long time favorite. I d not believe it will be easy to keep the employment share this low, but who knows. Someone may want to give the people a little more consumption. One problem is that the guys running China may be a little more infected (for instance by well meaning but misguided teachers in the 1970s)with notions about social fairness etc. Every student of Korea will agree that that does not get you to middle income/OECD status. Only prolonged effort and hardship gets you to the top. Consumption is for decadent westerners. Keep that employment share as low as you can and invest like crazy. Forget fairness, that is a luxury for countries in decline.

  • Posted by Italian reader

    Off Topic

    “President-elect Barack Obama will name former Federal Reserve Chairman Paul Volcker as the head of a special economic advisory group, sources tell CNN.”

    Very pleased, an opposit of Greenspan is very required

  • Posted by Chidambaram

    Volcker having a say means that interest rates are going to be raised, doesn’t it?

  • Posted by Qingdao

    I was disappointed in the report. I think what bothers me is the bland bureau-cratese: “Some of the stimulus measures give some support to the rebalancing of the pattern of growth from investment…to servvices.” Well, ok. Since Dec. 2004 when the leadership announced they were “rebalancing” this has been repeated ad nauseum. Compare the tone of this report to Prof. Roubini’s Forbes article, “Hard Landing in China.” If I had to choose one article to recommend this fall, I would recommend the latter. What does the WB say that is new?

  • Posted by Chidambaram

    @Qingdao,
    Do you have any real familiarity with what’s really happening in China? I’m looking for some sense of the real themes, and it’s not easy to infer from only these numbers.
    If people are recommending that China should increase Agency purchases and continue Treasury purchases, that’s not consistent with allowing RMB to appreciate against USD, or with increased import orders for our goods.
    China’s economy is rapidly collapsing in the face of the crisis, and the only logical course for them is to sell all the agencies and treasuries and focus on domestic demand development.
    There’s a huge regime change protest on in Thailand. The Survarnabhumi Airport in Bangkok has been temporarily closed after armed protestors have occupied it. Their demand is to dissolve the House and have new elections. Premier Somchai Wongsawat, who is a Chinese vassal, is standing off against the protest.
    Secondly the US agenda is to force China off the Tibetan plateau and they’re renewing the Tibet independence issue along with their Indian friends.
    Iron ore exports are piled up in India’s coastal ports, demand in India has nosedived, cars and houses aren’t selling. Every day there are rallies and protests in the big south Indian cities and today Islamic terrorists from the Deccan Mujahideen (another Islamic terrorist organization in south India) killed more than 101 and wounded more than 250 in commercial hotspots including five star hotels in Mumbai that are frequented by foreign business travelers.

  • Posted by Chidambaram

    If you want to know what might really be happening I recommend you start with this link:
    http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2008/06/12/the-geopolitics-of-china.aspx

    It tells you the geopolitical things that are relevant to full spectrum dominance in China, and those things will determine what the policy will be.

    You can also choose to be like one of Kissinger’s ‘dumb stupid animals’ who don’t understand foreign policy.

  • Posted by Chidambaram

    Here’s my summary of this link, hope it’s useful:
    China has three overriding geopolitical imperatives:
    1. Maintain internal unity in the Han Chinese regions.
    2. Maintain control of the buffer regions.
    3. Protect the coast from foreign encroachment.
    China’s geopolitical problem is economic. Its first geopolitical imperative, maintain the unity of Han China, and its third, protect the coast, are both more deeply affected by economic considerations than military ones. Its internal and external political problems flow from economics. The dramatic economic development of the last generation has been ruthlessly geographic. This development has benefited the coast and left the interior — the vast majority of Chinese — behind. It has also left China vulnerable to global economic forces that it cannot control and cannot accommodate. This is not new in Chinese history, but its usual resolution is in regionalism and the weakening of the central government.

    The question on the table is whether the economic basis of China is a foundation or a balancing act. If the former, it can last a long time. If the latter, everyone falls down eventually. There appears to be little evidence that it is a foundation. It excludes most of the Chinese from the game, people who are making less than $100 a month. That is a balancing act and it threatens the first geopolitical imperative of China: protecting the unity of the Han Chinese.

    http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2008/06/12/the-geopolitics-of-china.aspx

  • Posted by Charles

    Thanks for this post, Brad. I feel that many of the reports findings vindicate predictions I made long ago (not that they’re particularly original).

    I am hopeful that the Chinese government will use the appreciating yuan as an opportunity to raise living standards in China, particularly by reducing pollution and improving transportation, healthcare, education, and housing.

    The controlled development of a consumer economy will also bring a great sense of relief to China’s long-suffering people. I say controlled, because all of Asia has the problem of what to do when hundreds of millions of people suddenly want some good. It’s very disruptive to societies that tend to value order.

    One of the best tools of economic prediction is to look at what people want and what they’re willing to sacrifice. They will tend to shape their economy in the indicated directions. I hope that means a time of better conditions for the average Chinese, as well as a revival of manufacturing and a decline in poverty in the United States.

  • Posted by bsetser

    Qingdao –

    the value of the WB report is its data and hard numbers, not necessarily its policy prescriptions. if you look at the data it contradicts most of the reporting on china — which has focused on the export slowdown (which to data has been limited to a few sectors) rather than the far more important slowdown in domestic investment.

  • Posted by adiemuso

    Chidambaram,

    Not a Thai expert myself, but I think you got the basics of the current Thai standoff wrong.

    It is a clash of Thai vs Thai. The Rich,Middle,Academia vs Thaksin led Rich and mainly rural Poor.

    Im not too sure if the current PM is “chinese vassal”, but im certain the term is wrong.

  • Posted by Howard Richman

    The World Bank is dreaming when they wrote, “Our forecast for 2009, which sees GDP growth of around 7.5 percent based on current projections of global economic trends, has more than half of that coming from government-influenced spending.”

    They didn’t understand what happened in China yesterday. They don’t know what’s happening today. And their projections are ridiculous about what will happen tomorrow. Yesterday, the Chinese unemployment rate shot up, hidden by phony unemployment statistics. Today, the planned stimulus package is largely export subsidies, described by Michael Pettis as “Smoot-Hawley-with-Chinese-characteristics”. Tomorrow the 40% of their GDP that is investment will collapse causing negative economic growth, not the +7.5% projected by the World Bank.

    The failure of the World Bank economists to understand what is happening in China is breathtaking. Check out my latest blog entry for the real story.

    Howard Richman
    http://www.tradeandtaxes.blogspot.com

  • Posted by Movie Guy

    Brad,

    So, you don’t know how to respond to the CDS question?

    It has international implications.

  • Posted by Qingdao

    @Chidambaram: I live in China; does that give me any “familiarity”? Your assertion that America wants to “push China off the Tibetan plateau”is silly. Next question?

  • Posted by Euraussian

    Brad,
    Thinking a little more about your expectation that in the enar furure China and the US will each have the bulk of the world’s surpluses and deficits respectively, it appears that that -assuming that China has no realistic opportunities to boost domestic spending in he short term- the only effect is that a very large share of the world’s USD denominated savings will be in the hands of investors with a much higher risk aversion than during the past 10 years (the ADIAs and carry-trade-practising funds would buy some equities qs well. For the Chinese, even agencies are too risky. That may make a recovery much more difficult.

  • Posted by Euraussian

    Brad,

    Perhaps,
    once you have become the new President’s special advisor for US-Chinese financial affairs, you should consider a withholding tax specific to central banks etc with certain characteristics (for instance, Chinese characteristics) set a fixed percentage of principal (not interest) in order to encourage alternative investments. If tht would not help perhaps e Redemption tax of, say 30%?

  • Posted by London Banker

    Brad writes: “The Treasury market obviously isn’t worried – not it 10 year Treasury yields are under 3%. And there is little reason for the bond market to be worried if current trends continue.”

    To that I reply:

    A trend is a trend is a trend
    The question is will it bend?
    Will it alter its course
    Through some unforeseen force
    And come to a premature end?
    – Lord Cairncross

    What conditions could cause China to alter the trend of supporting US debt escalation? I can think of several possibilities, many of which have been discussed here over the months and years. That alone should keep us all wary and alert.

  • Posted by Doc at the Radar Station

    …the far more important slowdown in domestic investment.

    I’m looking at figure #5 where real yoy growth is plotted for “fixed asset investment” and “FAI in real estate”. How is commercial/industrial real estate segregated in this dataset-what are the components of each here? Steel and cement production are way down, so that implies CRE is being impacted greatly, and that would imply that construction of physical plant is down.

  • Posted by Chidambaram

    @Qingdao: Thanks for the clarification on Tibet.

  • Posted by ndk

    The Treasury market obviously isn’t worried – not it 10 year Treasury yields are under 3%.

    You’re looking at nominal yields, Brad. Real yields as measured by TIPS spread have risen noticeably, and now they’re very close to eclipsing the nominal yields at the 10yr. They’ve already done so for every shorter maturity.

    Treasury CDS have also hit a record high of 56. It speaks volumes that that has become an indicator to watch.

  • Posted by DJC

    Brad,

    Please take your complaints about Chinese manufacturing to Walmart corporation executives. It is amazing that the biased US news media always blames the OEM Chinese manufacturer for any quality control problems, rather than the American-owned importer and distributor.

    Directly accounting for upwards of 10% of U.S. imports from China, the Walmart corporation de facto dictates the “China price” and associated quality control standards. In fact, Walmart’s global procurement headquarters is located in Shenzhen China. Walmart directly contracts with OEM manufacturers and global shipping corporations for transporting hundreds of containers weekly from Hong Kong to Long Beach, California.

    If you believe China’s workers should secure a bigger share of China’s output, then why does the U.S. Chamber of Commerce bitterly denounce recent Chinese government legislation requiring foreign multi-national corporations to permit Chinese unionization. Over time, China will become increasingly less dependent on the U.S. Economy, but the key is “less dependent” as it may take decades to become independent.

    LOL. :-)

  • Posted by DJC

    What conditions could cause China to alter the trend of supporting US debt escalation?

    Well, it is simply beyond the economic capacity of the China PBoC to support $2 trillion of debt securities by the US Treasury in fiscal 2009. I would think that Chinese government authorities would be much more concerned about domestic political instability than what Hank Paulson and Ben Bernanke think. In Congessional testimony, Fed Chief Bernanke when asked by Congressman Ron Paul about his concern for China PBoC purchases of US Treasury bonds replied that, “The China PBoC will be forced to indefinitely purchase US Treasury bonds in order to maintain the value of their existing $2 trillion holdings”. We shall soon discover the economic results of the global ponzi scam resulting from US Dollar hegemony.

  • Posted by Chidambaram

    China should get one of their people to translate the Swiss Banking Secrecy Laws, translate them very exactly into Mandarin and Canton, and pass them unanimously as the new Chinese banking laws to deal with the crisis.
    Suppose you are a crooked policy maker announcing a big fiscal stimulus and you know that including yourself everybody down the hill is going to steal their bit out of it. You have to make sure that the money doesn’t end up in numbered swiss bank accounts, and not re balancing the villages against the roaring big cities.
    Having banking secrecy laws will make sure that the domestic financial system gets allt he liquidity in any case. Swiss banks are already quite liquid and don’t need new deposits to deal with this crisis.

  • Posted by don

    “What conditions could cause China to alter the trend of supporting US debt escalation?”
    My guess: If it ever happens, it will be the result of pressure from the U.S. to reduce currency interventions.
    I think the driving force behind the slowdown in investment and real estate in China is declining export prospects.
    I strongly second ndk’s comments.

  • Posted by Charles

    Movie Guy, why is Brad’s opinion on CDS so important? He’s doing a great job on capital flows, Exim, and other trade topics of interest. Credit default swaps seems off the track of his interest. Nouriel would be the go-to guy.

  • Posted by Movie Guy

    Charles,

    First, there are international implications related to the ongoing financial crisis. If Brad doesn’t understand the implications then he’s behind the curve. But I believe that he knows that there is a major problem with CDS payouts and that the Fed is essentially covering the front end of those positions.

    Second, Brad highly endorsed Tim Geithner’s nomination for SecTREAS as I assumed that he would. If you take a good at Geithner’s positions and recommended courses of action related to the financial crisis it’s likely that he will continue to support the same courses of action taken thus far by Bernanke and Paulson. So, expect no change. And that brings us right back to CDS payoffs. Try reading Chris Whalen for a better understanding of that mess.

    You can find his Chris Whaten’s commentary at the Big Picture under BP Cafe. Same story for the New Yorker article (Dec 1) where Bernanke and Paulson are the primary focus.

    I am confident that Brad has some appreciation for why I asked the question. If he doesn’t understand the impact, then he should plug it into his thinking and add it to some of his presentations. To do otherwise is to miss a large portion of what the global financial crisis involves.

  • Posted by ndk

    My guess: If it ever happens, it will be the result of pressure from the U.S. to reduce currency interventions. I think the driving force behind the slowdown in investment and real estate in China is declining export prospects.

    I see your point here and on Econbrowser now. I think you’re right.

  • Posted by ndk

    Interesting. Brad has pointed this out before, but it’s crystalizing for me now.

    It’s not clear at this point that China could change the exchange rate without bankrupting their own PBoC. They have foreign assets denominated in dollars, and domestic liabilities denominated in yuan. Write down those $2 trillion dollars by 30%, and… heh.

    This strengthens my conviction that they intended to inflate their way out of the problem in the first place, because then they could make up the losses through quiet seigniorage.

  • Posted by Euraussian

    Chidambaran,

    You may have never seen a Swiss bank from the inside. Swiss banking law does not protect criminals and is in the process to become less protective of even fiscal offenders abroad. Locals enjoy not much more protection than people in other countries. So it would not work for the Chinese gvt to adopt the swiss bank secrecy system (assuming that’s what you mean) because money would still trickle offshore (although that is a lot less easy than in most countries).

    Furthermore: typical swiss private banking rvolves around “fiduciary accounts” where the Swiss bank acts as agent, and not as principal. Whether the bank is liquid or not does not matter, only your own risk appertite as to the (usually non-swiss ) bank where you instruct the Swiss bank to place your money.

    Finally, it would be a lot easier for the Chinese to copy the mandarin versions of the various Singaporean statutes and ordnances relating to banking and confidentiality in particular…Singapore is offers quite a bit more secrecy than Switzerland these days, but also, not where Singaporeans want to hide things from the Sporean state…

  • Posted by Chidambaram

    Singapore isn’t a free democracy, it’s somewhat controlled, imagine what the scenario would be like if one of our parties were continuously in power for around 50 years or so … the other one would be really weak in practice.

  • Posted by Euraussian

    Chidambaran,

    What has Singporean (lack of) democracy to do with my suggestion that it would be easier for the Chinese to adopt Singaporean laws that are already available in a Mandarin version?

  • Posted by Chidambaram

    Would appreciate latest updates on foreign strategic investment in China’s Commercial Banking Sector:
    Specifically does anyone know the latest status of China Banking Regulatory Commission discussions with FDIC, and the latest rules on controlling stake in Chinese banks?

  • Posted by Judy Yeo

    deficits and surpluses are products of the dual entry accounting identity used (but mostly despised) by theoretical economists/academics, it presumes equilibrium. that in itself is debatable . In the long run there is equilibrium but in the short or intermediate term, that’s highly questionable. as for the long run, need anyone repeat keynes’ insight?

  • Posted by Chidam

    The purpose of this essay is to get to the real themes in China and analyze them, without any national origin or ideological bias, to determine the best course of action for private market participants.
    The broader conflict is ideological, between the United States model of capitalist enterprise in a democratic framework and the Chinese model. The Chinese economic model in practice today is a mix of state owned enterprises and private enterprises with statutory limitations on private participation in the economy. The political model is one where there’s internal accountability within the Communist Party but without a robust wider accountability to the general public through free elections.
    The broader conflict has several themes, and the main ones are:
    1) Privatization and liberalization of the commercial banking sector
    2) Privatization and liberalization of state owned enterprises
    Disagreement over the above two themes leads to another theme of economic conflict:
    3) Trade imbalances between the United States and China, with the focus on exchange rate imbalances
    4) The trade issue can easily lead to a major escalated conflict in the diplomatic and military spheres.
    1) State owned Commercial Banks:
    Banking sector reforms are the main theme in China. Allowing purchase of controlling stakes in China’s banks by foreign strategic investors is the source of disagreement between the Communist Party and the United States. Since 2006, China Banking Regulatory Commission has liberalized the banking sector and allowed strategic investors to acquire stakes in China’s small and medium sized banks without a cap. The four largest state owned banks have a 20% limit on individual investor stake and an overall 25% limit on foreign investment.
    2) State Owned Enterprises:
    Reform of the state owned enterprises to ensure a level playing field with private companies and allowing foreign investment in those enterprises is a source of disagreement.
    Implications of a Hard Landing:
    If there’s a hard landing in the Chinese economy, that’s an opportunity for foreign banks to consolidate their stakes in the local banks and local corporations.
    Current Policy Direction:
    The Communist Party’s policies are to ensure that there’s no hard landing and emerge from this crisis as they did after the East Asian crisis of 1997. The Communist Party is propping up the export sector with continued exchange rate interventions and a massive fiscal stimulus to stimulate local demand. If this policy is continued successfully, the current structure of the big four banks and the state owned enterprises will survive the on going credit crisis.
    The United States intention appears to be to disrupt the continuation of that structure. In an ideal world China will do as this World Bank quarterly report suggests. They will liberalize and open up the banking and other sectors for foreign investment. Then they will correct the exchange rate imbalance. This will ensure the collapse of the export sector and the banking sector that has exposure to the export firms. Insolvent banks will be ‘resolved in an orderly manner’, and the wording indicates that that manner is the opposite of that prescribed for the likes of Goldman Sachs, Citigroup, AIG, etc.
    Once the export sector comes to a standstill and the banking sector collapses, the liberalized system advocated will allow a few foreign banks to buy up almost all of the banking sector in China.

    I don’t think that the Communist Party is going to listen to this. That takes the conflict to the next stage, which is basically a trade war.

    China’s exports are composed of 50% to other emerging markets, and the share of exports to the US is not as high as it’s made out to be. Sanctions or import restrictions from the United States will mean that China’s export sector will continue with exports to other countries. Combined with a large fiscal stimulus and continued exchange rate interventions on the consuming currencies, once again the Communist Party will succeed in maintaining their rule.

    To meaningfully enforce a trade embargo, the US has to blockade China’s Eastern Coast, since most of the exports are by sea. Setting up bases in countries like Thailand (Gulf of Thailand and South China Sea Blockade), Taiwan (East China Sea blockade), Sri Lanka (Indian Ocean blockade) and various other scenarios need to be considered for that.

    The other way to enforce a trade embargo would have been to sanction against petroleum supplies to China. Through bilateral agreements and the oil pipelines from Kazakhstan and the planned one from Myanmar, China has ensured that petroleum supplies will continue.

    However it’s not possible to fully evaluate a trade war against China in isolation. There are diplomatic and military consequences of a global nature to that.

    The ongoing crisis can only end if there’s a diplomatic resolution to the question of ownership of China’s banking sector in between, which will possibly avert escalation to a full trade war.

    Again, around the world, there are several such considerations to be resolved, and it’s not possible to evaluate the entire global crisis without looking at all of them.

    Though Roubini’s prediction of a hard landing in China is not based on any sound economic reasoning, a hard landing in China is a strategic intention of US policy, and it is made more likely due to that intention being there.

    What I would conclude from this analysis from a private investment perspective is that it makes sense to make cautious investments in stocks of Citigroup, Bank of America, Goldman Sachs, AIG, etc since the powerful Washington policy establishment is providing selective support to those entities as opposed to others.

  • Posted by Twofish

    About workers wages. The reason that workers wages are a smaller percentage of GDP was that in the 1990, the state owned enterprises were broke, and the large fraction of GDP that was put into workers wages was driven by bank lending that was unsustainable.

    If you increase the fraction available to workers wages, then you run the risk of companies having insufficient capital reserves to survive an economic downturn, and you end up making the financial system more susceptible to crisis. From 2000-2008, the corporate sector had to pay off the non-performing loans of the 1990′s and also develop a capital cushion.

    In any case, productivity means that you end up with strong increasing workers wages, even though they are a smaller share of GDP.

    2) Given China’s size, it is pretty clear that China cannot continue to grow by investing ever more and manufacturing ever more. China ultimately has to produce for Chinese demand not world demand.

    I don’t see how this follows at all. The fact China has to produce for Chinese demand makes it more important that it make huge investments in manufacturing to increase productivity. This is going to be especially important once the population ages very rapidly.

    bsetser: Why then is China slowing so sharply? Simple, real estate investment has hit a wall. After growing at 20% y/y for a long time, real estate investment stalled – with a y/y growth rate of around 0% (Figure 5).

    True. Most of the current economic slowdown really has nothing directly to do with credit crisis and everything do to with the fact that Chinese leaders were alarmed at the inflation rates late last year, and slammed on the brakes.

    I really don’t see how and of this has to do with the currency policy, or how changing RMB exchange rates in 2003-2006 would have changed much.

    4) The fiscal stimulus is real, but modest. China’s fiscal balance is expected to swing from a 0.7% of GDP surplus in 07 to a 2.6% of GDP deficit in 09.

    But what that’s only the tip of the iceberg. What will likely happen is that a change in policy will encourage state-owned enterprises to start some massive investment with their retained earnings. There is a lot of “hidden deficit spending” that occurs at the local levels, and my guess is that this will grow much faster than the official central government earnings.

    My own view is that the Chinese government took very good policies over 2003-2008 in that they encouraged savings which makes the financial system less susceptible to economic crisis, and a lot of the policy prescriptions that Western economists had given would have had the effect (and did have the effect in the West) of removing the cushions that prevent a downturn from turning into a crisis.

  • Posted by Twofish

    The other thing is that there is a danger of whipsawing. A year ago everyone was worried about inflation and Chinese economy overheating, and so the PBC slammed on the breaks in late 2007. We really run the risk that with everyone doing stimulus, that in six months when all of these packages hit that we will be in a very different economic environment.

    Also I’ve found that GDP projections are pretty useless for telling you want the GDP will be a year from now. They tell you want people now think the situation a year from now will be.

  • Posted by Twofish

    Chidam: China’s economy is rapidly collapsing in the face of the crisis

    No it’s not. Neither is the US economy.

  • Posted by Twofish

    bsetser: if you look at the data it contradicts most of the reporting on china — which has focused on the export slowdown (which to data has been limited to a few sectors) rather than the far more important slowdown in domestic investment.

    Precisely, and the slowdown in domestic investment was ordered from on high late last year, and it’s something that can be reversed. They slammed on the brakes, now they are going to start hitting the accelerator.

    There is also a “cry wolf” characteristic to China commentary. Every time something bad happens, there is this expectation that *this* will be the thing that sinks the Chinese economy. When in reality, this crisis has been nowhere as bad as some of the other things that have happened over the last thirty years.

    The big unknown is the US economy. No one has any clue how long or deep the US recession will be.

  • Posted by Chidam

    Well that’s good , but lots of people’re losing jobs in China, there’s a photograph up on Pettits’s web page.
    What’s your opinion on the real themes I’ve identified?
    China has scored a major diplomatic victory with Taipei. That rules out a base in Taipei without a regime change … it would be impractical.

  • Posted by Chidam

    Apart from having rules out the Taipei item on the embargo possibilities I’m now busy reading up on the various sources of conflict with Russia. I always used to goof at Iran’s claims to having plutonium bombs and so on but I’m reading that the Russians have completed a civilian nuclear reactor in Iran and Iran has been re processing uranium from the reactor.

  • Posted by Twofish

    Stratfor has some good geopolitical commentary but every time they start talking about economics, they start talking nonsense.

    The fact that China has so much treasury reserves makes it impossible for the US to do anything that infringes on what China considers its vital national interests without everyone going down a cliff (and vice versa). Everyone has to be nice to each other.

    Also you have to look at the details, and sometimes there are surprising alliances. For example, the central government has allowed foreign banks to get seats on the boards of the big banks and major corporations because the central government trusts Western outsiders to monitor the banks and corporations on behalf of the central government more than they do local Chinese who are much more easily captured by the banks and corporations they monitor.

    Also the division between China and the West isn’t that clear, since there are lots of Chinese working in Western banks, and lots of Chinese that work for the Chinese government have spending a decade or two overseas.

  • Posted by Chidam

    Twofish:
    My own view is that the Chinese government took very good policies over 2003-2008

    I agree, and I also think their $4 trillion fiscal stimulus with continued support to the USD exchange rate and export tax rebates will help them to meet this crisis successfully.

    On the other hand if they listen to World Bank, IMF, or Roubini, there will be a hard landing crash followed by a takeover of the banking system …

    it’s really simple @ Twofish

  • Posted by Chidam

    Twofish:
    Also you have to look at the details, and sometimes there are surprising alliances.

    The big four banks have a limit on foreign equity participation (20% per investor and 25% overall foreign). Other banks have no cap on FDI. BoA recently hiked their stake to 20% in a Chinese big four bank.

    Citi and other foreign banks have been allowed to do RMB business and have opened branches in China. Citi has a controlling stake in Guandong Bank that it won in Nov 2006.

    And it was a RMB 4 trillion fiscal stimulus sorry for the error above.

    Overall I think the conflict is about the cap on the big four banks, that are by far the largest ones, one of them is the second largest bank in the world.

  • Posted by Twofish

    Chidam: Well that’s good , but lots of people’re losing jobs in China, there’s a photograph up on Pettits’s web page.

    Photographs can be misleading as can journalist reports on individual incidents. The New York Times for example, reports on a riot over back wages and factory closings in Shenzhen, missing the point that there are always back wage riots and factory closings in Shenzhen. If you look at statistics, the export downturn hasn’t hit yet.

    A “walk in the street” can tell you what the situation is.

    Also, one test to see if you have a reasonable scenario is to see if it sounds like it makes a good Tom Clancy novel or movie. If it does then it’s probably not a realistic scenario. In particular real world event are often determined by bureaucracies and committee reports and policy papers make really dry reading, and some things don’t change much in a day or two. You really have to familiarize yourself with how China, Russia, and the United States makes decisions.

  • Posted by Twofish

    Chidam: The big four banks have a limit on foreign equity participation (20% per investor and 25% overall foreign). Other banks have no cap on FDI. BoA recently hiked their stake to 20% in a Chinese big four bank.

    And 25% participation (and a board seat) in a big bank is plenty for the US banks. It’s far, far higher than the US would let any Chinese company invest in a US megabank. There is no way that the Fed would let a Chinese company have a board seat on any US bank, and there is also no way that a Chinese investment in US banks would pass CFIUS review which kicks in at 10%. It’s just not going to happen.

    The PRC has its hands full just trying to get the US to allow PRC banks to operate in the US.

    So if the US wants the PRC to open up the banking system, Beijing can push back with, fine we put our limits on the table if you put your limits on the table, and at that point the conversation ends.

    Investments in smaller banks are done by a case-by-case basis. The problem is that anything a government will let you invest in is probably something that you don’t want to invest in.

  • Posted by Chidam

    @ Twofish
    Great one with the Tom Clancy quip. :-)

    But it looks more and more like a sinister John le Carre word twister with a set of favorite banks getting all the bailout billions, and them using the money and the favortism to buy all the banks in far off Beijing.

  • Posted by Chidam

    Twofish:
    It’s far, far higher than the US would let any Chinese company invest in a US megabank.

    We’re avoiding any national bias here but genuinely on balance it’s a situation where the Chinese economy is booming through exports to foreign countries so those countries should be allowed more equity in the local businesses. The US on the other hand has been the biggest deficit builder in return for both foreign aid, campaigns as well as imports. So it doesn’t make ‘equal’ sense for Chinese banks to be allowed to own large stakes in the US, according to me.

  • Posted by Twofish

    Chidam: But it looks more and more like a sinister John le Carre word twister with a set of favorite banks getting all the bailout billions, and them using the money and the favortism to buy all the banks in far off Beijing.

    It’s actually not. One good thing about the internet is that you can meet people who talk about what they are seeing directly, and no one in Wall Street is happy right now.

    Also, it is trivially easy to come up with a justification for just about anything. That’s why I don’t think that arguments about what is “fair” or “equal” really mean very much when you look at the real world. What is good for me is fair and equal. What is bad for me is unfair and unequal. And what people usually do is they start with the outcome and then come up with the justification.

  • Posted by Chidam

    @ Twofish

    I’ve only found one explanation to this crisis that fits almost everything. There’s a geopolitical objective behind this crisis, and it was deliberately triggered to meet that objective. This crisis will only end after the objectives behind it are attained.
    Everybody was lending and borrowing, and the amount of credit flow is always increasing, which is why I describe it as a spiral flow, with the US homes at one side and the investors in low rated bonds at the other. Secondly you have PBoC accumulating Treasuries rather than liquid reserves, which is why I think their end is narrow, making it an ostrich egg spiral. It’s an elongated spiral because you have many layers of securities between the two ends, you could have a flow going from a mortgage loan to an MBS to an MBS CDO to an investor, then there could be CDS on that flow with more synthetic CDO based on the CDS, and then investors for those CDOs, there’re primary and secondary CDOs to add… and so on.
    Now obviously if you give any shocks to this global system, the whole system will simply collapse, because everybody is connected into it. It’s like this glass bridge that the British architect whatever his name was built. He placed glass panes vertically together like books, and then applied pressure to both ends. The tops of the panes form the walkway of the bridge. If you remove the pressure at either end, the glass bridge will just collapse.
    When the speculators doubled the oil price, it created enough shock for the system to collapse. (This isn’t a new idea. There was a 400% increase in oil price after the 1971 non convertibility of the dollar.)
    You can also add to the trouble by allowing Lehman to collapse and by deliberately discrediting the Agencies. The Lehman collapse and the non guarantee for the Agencies made the crisis spread around the world.
    Once the system collapses, it brings a lot of power because now you have all the banks and companies going bankrupt without any money flow, and demand has also collapsed.
    The favorites get the special loans and bailout equity capital; then they buy out everybody else around the world. Simple, isn’t it?
    I think that the banks are busy transferring their new credit to other country branches and waiting to buy out as much as they in these so called bad times.
    This isn’t new either. Korea didn’t have either a major surplus or deficit in 1998, and the IMF made the same conditions as in this World Bank paper. Korea was asked to open up the economy for foreign investors and allow direct borrowing from foreign banks. Korea got an IMF loan and the subsequent recovery was led with foreign bank ownership and funding.
    Now the crisis won’t end till the geopolitical objective of it is complete. But it’s hard to dictate things to the Red Dragon like you can dictate to Korea. And my doubt is whether Washington has understood that or not, especially looking at these foolish policy recommendations.

  • Posted by Twofish

    Chidam: I’ve only found one explanation to this crisis that fits almost everything. There’s a geopolitical objective behind this crisis, and it was deliberately triggered to meet that objective. This crisis will only end after the objectives behind it are attained.

    People who see conspiracies everywhere miss the real conspiracies. Usually the real conspiracies are quite open. If you want to know what Beijing or Washington or Wall Street really wants, just ask, and they’ll tell you what they want, what they are doing to get it, and why.

    Usually it’s very simple. People want money and power. The way of getting money and power is usually very simple and direct and very transparent. If you have to invent some complex, crazy, Rube Goldbergish scheme, then you are probably missing what is going on, Hidden conspiracies made great movies, but they rarely tell you want is going on.

    In the world there is a lot of random events, unintended consequences, conflicting agendas. You also have to remember that nothing goes occurring to plan, and plans that require that everything go according to plan generally fall apart badly when the meet the messiness of the real world. Starting a crisis to meet some policy objective is usually very stupid since historically it turns out that once you open Pandora’s box. you can’t close it back even if you wanted to.

    Chidam: The favorites get the special loans and bailout equity capital; then they buy out everybody else around the world. Simple, isn’t it?

    No because anything that threatens the world financial system threatens the power of the people that run the system. People that start crises invariably end up destroying themselves, and the people on Wall Street that actually run the financial system have enough sense to realize this.

    Also, if you have that much control over events then starting a financial crisis is pretty stupid since you can just order the people you want to be paid to be paid. Why be so complicated?

    Chidam: I think that the banks are busy transferring their new credit to other country branches and waiting to buy out as much as they in these so called bad times.

    No. People in bank are busy transferring their credit into cash so they survive the bad times. They aren’t lending because they don’t want to take on any risk at all.

  • Posted by Chidam

    @Twofish
    There’s a lot of common sense in what you’re saying. I’m not looking at a conspiracy. It seems to be a deliberate long term strategy that’s always been followed. And you can easily convince people that the business cycle is real and that market equilibrium is false.

  • Posted by Euraussian

    Twofish,

    I admire your patience. You should charge for your private tuition.

  • Posted by Chidam

    Citigroup now has unlimited federal support under the new parachute bailout model. Under the terms of the agreement, Citigroup will cover the first $29 b of pretax losses from their $309 b asset pool, in addition to reserves it has already set aside. Citigroup will accept 10% of losses above $ 29 b, with the government responsible for 90%. As the losses plummet more than $29, Treasury will come in and take up to $ 5 b in losses, followed up by FDIC to take another $10 b in losses. If this is not enough the Fed will billow out a parachute loan.

  • Posted by Chidam

    @ Twofish
    The only agenda in the ongoing financial crisis is to ensure that a small favorite group gets to control all the banking systems around the world. Till that is in place the crisis won’t end. Anybody who ignores the irrefutable logic of this is going to lose a great deal of money. Makes sense to put your money in Citigroup, Goldman, JP Morgan before it’s too late. But don’t goof up, be cautious, buy in delivery, and put in only a fraction of your total money in these stocks. United States will win this conflict for sure because it’s a conflict between a fundamentally better model – democracy and other models.

    (Note that it isn’t a nationalistic argument. Democracy creates a more accountable social allocation mechanism towards common goals, and it’s not perfect.
    And also note that all the jokes regarding various people are directed at their ideas rather than at them personally.)

  • Posted by Chidam

    And given the geopolitics, the emerging market infrastructure sector will boom starting now, even before the crisis gets resolved.

  • Posted by Chidam

    @ Euraussian:
    The usefulness of blogging is to see if there are more accurate alternative perspectives that should make you change your mind.
    You have to understand that my interest is in making some good money out of this crisis. In so called bad times smart people make much more money than in the so called good times.
    The conspiracy theorists clearly have an anti-American political agenda. But if they have correctly identified the real agenda, it gives you a chance to make really good money. And that’s part of the beauty of the American model. If somebody can manipulate the American system to make money, then if you know that they are doing that, you can share the profit in the open market.

  • Posted by Twofish

    Chidam: The only agenda in the ongoing financial crisis is to ensure that a small favorite group gets to control all the banking systems around the world.

    No that’s not the agenda. The agenda for pretty much everyone in finance is to make as much money as possible for themselves. The problem with the scenarios that you’ve mentioned is that its hard for me to see the point at which someone cashes out and make huge amounts of money.

    Frankly, I don’t see how having a small group control all of the banking systems around the world will help too many people outside that small group make money, and so unless you are in that small group, I don’t see the point in helping them. Since most people aren’t in that small group of people, this plan is going to run into problems.

    Also, banking is difficult, and often you make a lot more money by not being in control. If a US bank ends up controlling the banking system of North Elbonia chances are that they’ll end up destroying it. It’s better to keep the North Elbonians in control and then come to some agreements that get you what you want.

    Chidam: Makes sense to put your money in Citigroup, Goldman, JP Morgan before it’s too late.

    No it doesn’t. If you are of the opinion that there are a group of people that are intent on destroying the world for their own purposes, then it’s stupid to give them any of your money. If someone has no ethics and is willing to destroy the world to make money, then they are likely willing to destroy you also to make that money.

    Chidam: United States will win this conflict for sure because it’s a conflict between a fundamentally better model – democracy and other models.

    Democracy is a marketing term. You can come up with an excuse to call any political system “democratic” so it’s pretty much a meaningless term if you want to think about what’s going on, and it’s main usefulness is to get people to stop thinking.

    Also, thinking that you are going to win is a very dangerous thing. The key to winning any conflict is to know your own strength and weaknesses, and this is very difficult. One trick is if that you really want to know the strengths and weaknesses of the United States, don’t ask an American, ask a Canadian.

    In any case I don’t see what any of this has to do with investment banking. There is no particular reason I can see that a British national working for a Swiss bank with a Russian supervisor in Dubai should act in American geopolitical interests.

  • Posted by Chidam

    Twofish:
    There is no particular reason I can see that a British national working for a Swiss bank with a Russian supervisor in Dubai should act in American geopolitical interests.

    Despite all the propaganda over fabulous million dollar bonuses and what not, I-Banking works just like the freakonomics of drug peddling. Look up the ownership of the US big four – Citigroup, JP Morgan Chase, Goldman and Bank of America. The owners of the banks and the I-banks are very few and all these various nationals are just worker bees with fancy tags. Though they don’t live with their parents they’re only making as much money as smart plumbers, though they’ve taken big loans to get costly degrees from Hyde Park and so on.

  • Posted by Chidam

    George Soros never ‘broke the back of the Bank of England’ or anything like that. The US didn’t appreciate the idea of a Euro currency and they kept their British friends away from it, which is what good old George was betting on in those days.

    More recently Warren Buffett was found holding US Treasuries in his personal account and he put $ 5 b from there in goldman stock. Berkshire Hathway’s equity and risky bond holdings were also at a minimum and they were in Safe Harbor as well.
    There isn’t any Oracle in Omaha, or even a psychic revelation shop in Jersey that tells these people what’s coming. They know what’s coming because they know the geo politics.

  • Posted by Chidam

    “This Foreign Policy stuff”, as George Bush rightly said, “is quite confusing”. It’s easy to pretend that you’re much smarter, and make fun of him; but I bet you’ll get quite confused yourself if you get into it. Personally I find that the names of the seas and oceans are more user-friendly than the names of unpronounceable places with oil pipelines like the Baku-Tiblisi-Ceyhan that’s going to lead to Ashkelon (or-whatever-its-name-was) in Israel.
    And we need to know basics like what the state secretary’s office calls “Eurasia”. I noticed that anybody who’s clever @ State these days is a specialist in a couple of countries somewhere, and “Eurasian Affairs”. You draw a line across from the English Channel all the way to the East China Sea, and all the land mass around the line is basically ‘Eurasia’.
    After the recent vice presidential debates on foreign policy, even the Newark Airport cabbies have started saying things like ‘I’m from Africa’ when you ask them which country they’re from. We could start the securitized infrastructure overhaul revolution by installing motion-sensor driven automatic paper towel dispensers in all the county airport restrooms, like we have in the shiny new Newark terminals.

    @Twofish: Where/what is North Estonia? … lemme search …

  • Posted by Euraussian

    Chidam,

    I appreciate your desire to make money out of this crisis (or should I say even in this crisis) and if you find an interesting way to do that by being active on this blog, pse let me know. As a gentleman, I would not give making money a high priority, but, circumstances change and my estate would benefit from a little extra.

    Question how do you do that as well as writing these profound and lengthy pieces?

  • Posted by Chidam

    @ Euraussian
    if you find an interesting way to do that by being active on this blog, pse let me know.

    The theme in China is a long battle over ownership of the Chinese banking system. We have to still see if the same theme has occurred in other places. I think Iceland, Hungary, Korea would be good places to look because these economies seem to have hard landed already. If you know the theme you can put money on the right banks and you will also know when the battle is over and the market is ready to change to a bullish direction. And you also have to try to get insights on currency movements and new sectors where there will be a boom, such as infrastructure.

    I’m active on this blog is because I find that it’s a blog where you get some real themes , insights, and reliable analysis of data. Scaremongerism doesn’t impress me one little bit, and nor does anti-American conspiracy theorizing.

    On the other hand if we’ve embarked on a financial crusade to unseat the corrupt bureaucrats in places like China and India, etc; I’m all for it, and I want to get a piece of that pie for myself as well.

    China and India will never develop as long as they have huge corrupt bureaucracies leaking taxpayer funds and unless they improve the democratic system. India should be able to reserve taxpayer funds for election campaigns because as long as the politicos there are raising money through private deals it’s only the lobbies that will benefit from the democracy.

  • Posted by Chidam

    Timeline on Ownership of China’s Banks:

    (I’m not able to upload the links so I’m putting up the headlines without the links. It should be easy to google up the corresponding news reports)

    November 28, 2008: Bank of China to set up Swiss private bank

    November 17, 2008: Bank of America increases holdings to 20% stake in China Construction Bank Corp.

    June 24, 2008: Obstacles have been cleared for two Chinese state-owned banks – the Industry and Commerce Bank of China and the China Construction Bank – to set up branches in the United States, according to industry sources.

    May 23, 2008: China Banking Regulatory Commission stand on foreign investment:

    April 07, 2008: The China Banking Regulatory Commission (CBRC) is soliciting public comments on a new set of rules governing bank controlling shareholders, perhaps paving the road for foreign investors seeking to take control of Chinese banks.

    Link to the CBRC notification:

    Link to previous World Bank Quarterly Update on China:

    October 29, 2007:
    Industrial and Commercial Bank of China buys 20% stake in South Africa’s biggest lender, Standard Bank Group Ltd.

    October 09, 2007:
    MINSHENG Banking Corp will buy 9.9 per cent of San Francisco-based UCBH Holdings for more than US$200 million ($294.5 million) in the first strategic investment by a mainland Chinese bank in a US bank.

    July 12, 2007: China Banking Regulatory Commission blocks bid from Carlyle, a US based private equity firm, to acquire an 8% stake in Chongqing City Commercial Bank

    November 16, 2006: Citigroup wins battle for China bank:

    April 25, 2006: China Banking Regulatory Commission disallows Citigroup bid to buy controlling stakes in small and medium sized Chinese banks – e.g. Guangdong Development Bank

    April 10 2006: China won’t cap small bank stake buying – China Banking Regulatory Commission

    January 04 2006: Mitsubishi UFJ confirms talks for Chinese Bank Stake

    December 2006 IMF Working Paper – Rise of Foreign Investment in China’s Banks – Taking Stock (views are not IMF official views)

    Page 12 and 13 consolidate data on foreign investment in the five largest banks in late 2006 or so

    Link to March 2006 IMF Working Paper with the focus on China Banking Regulatory Commission:

    19 August 2005: RBS seals stake in Bank of China

    IBM Global Business Services (2004) report on US IPOs of Chinese Banks:
    The focus is on state owned commercial banks.

  • Posted by Euraussian

    Chidam,

    You have lofty goals as well as a healthy dose of greed. Perhaps you should, indeed, buy some stock in Icelandic banks.

  • Posted by Twofish

    Chidam: Look up the ownership of the US big four – Citigroup, JP Morgan Chase, Goldman and Bank of America. The owners of the banks and the I-banks are very few and all these various nationals are just worker bees with fancy tags.

    I don’t see your point. The biggest shareholder for Citibank happens to be a Saudi prince and one of the largest block share holder in Goldman is a Japanese bank.

    In any case, shareholders have practically no power in large US corporations. The real power lies in the corporate management which effectively controls the board of directors.

    Chidam: The theme in China is a long battle over ownership of the Chinese banking system

    No it’s not. Access to financial services was settled by WTO agreements, and foreign banks have enough trouble trying to digest what they already have.

    Banking especially retail banking is about the details. If you spend too much time thinking about silly James Bond scenarios, you miss things that actually will make you money like offering free hot apple cider in the winter.

  • Posted by Twofish

    Chidam: China and India will never develop as long as they have huge corrupt bureaucracies leaking taxpayer funds and unless they improve the democratic system.

    The problem is that you get what you pay for. If you want to end bureaucratic corruption, you have to pay bureaucrats decent salaries.

    Also one thing about China is that in comparison to developed countries like Sweden, it is seriously undertaxed. You need decent tax rates to pay for honest efficient bureaucrats that will then generate economic growth that increase tax revenues.

    Chidam: There are raising money through private deals it’s only the lobbies that will benefit from the democracy.

    Lobbies and special interests are the very fabric of democracy. You just have to make sure that everyone has there interests represented by some lobby or special interests and that the various groups are balanced so that no one gets too strong or too weak.

  • Posted by anon

    Nov. 30 (Bloomberg) — Palaniappan Chidambaram took over as India’s home minister, replacing Shivraj Patil, who resigned today after taking moral responsibility for the worst terrorist attack in the nation in 15 years.

  • Posted by Chidam

    I’m quite distant from Palaniappan Chidambaram … would like to avoid any confusions over my name.

  • Posted by Chidam

    @Twofish: My above sequence of reports isn’t really complete. You need to see the total assets of the commercial banking, divide it up to big four and non big four, look at the holdings of foreign banks in the smaller ones by break up and similarly foreign holdings in the big four to see if there’s a reason to think that the foreign banks want more holdings and haven’t been getting it during the boom.

    Secondly, unless the economy goes through a hard landing there’s no question of buying big stakes in the banks. That can happen in a situation like Iceland or the US itself.

  • Posted by bsetser

    Movie Guy — my understanding of CDS isn’t quite strong enough for me to feel comfortable answering your question on the fly, and I was serious about taking a few days off. There were a host of problems with CDS: a) too many were traded over the counter, creating a mess with counterparties (One contract offsets another than offsets another and so on, leaving everyone – or too many at least — too interconnected to fail) and b)CDS were a way of making leveraged bets on credit (writing insurance in the expectation you wouldn’t need to pay = easy way to gear up — it was effectively a way of borrowing to buy a bigger portfolio of risky bonds) as much as a way of hedging credit exposure (tho it is used for that too — see argentina in 01 … )

    but more importantly, i was serious about taking a few days off!

  • Posted by Euraussian

    CDSs are basically credit insurance (or guarantees) by another name, but dressed up in ISDA technology. The regulators should never have allowed these things to be used for regulatory arbitrage. It is still a mystery to me how there could be so much appetite for writing CDSs on mortgage based credit risk. Perhaps those risks are not as bad as they look now, but worse than they looked then.

    Brad, re the employment share again (now your holiday is over), my earlier comments were of course not quite serious (although reflective of some people’s thoughts) .

    I looked at it again and it is getting absurdly low. One contributing factor could be the large numbers of peasants and unofficial city dwellers (suggesting that perhaps up to 80 million incomes should really be in the employment category). Another could be taxation (foreign firms leave excess profits in China for tax reasons and in the belief that any exchange rate change will be profitable).
    Many Asian countries have low employment shares. Even a country like Singapore with only 70.000 self employed and no farm sector has an employment share of around 50, and had that for a very long time. Singapore’s household consumption number is about the same as the employment share, suggesting a reasonably low discretionary savings rate. But in the case of Singapore it is assumed that the government and the corporate sector are quite profitable (and it is a widely assumed that Singapore is a country that attracts accounting profits for tax purposes (re-invoicing etc). Consider also the famous confidentiality of Singapore-Indonesian BOP data.

    But however one looks at it, it remains a bit too strange to have a good economic explanation. A definitional anomaly perhaps?

  • Posted by tyaresun

    Pretty depressing numbers out today:

    The Purchasing Managers’ Index fell to a seasonally adjusted 38.8 in November from 44.6 in October, the China Federation of Logistics and Purchasing said today in an e- mailed statement.

    The yuan fell 0.22 percent to 6.8497 against the dollar as of 9:41 a.m. in Shanghai, the biggest decline in more than a month, as the government sought to help exporters.

    Export orders, output and new orders all contracted by the most since the survey began in 2005.

    China’s export orders declined to 29 in November from 41.4 in October, the survey showed. A reading above 50 reflects an expansion, below 50 a contraction.

    The output index fell to 35.5 from 44.3, while the index of new orders dropped to 32.3 from 41.7.

  • Posted by Chidam

    If any economy goes through a hard landing, a bulk of their banks will go bankrupt and that creates an opportunity to buy out big stakes in their commercial banking system with very little equity investment.
    I checked out the ownership of the commercial banking sector in India. Reserve Bank of India permits 74% foreign holding in private banks and 20% foreign holding in the public sector banks. Also foreign banks are operating through local branches and wholly owned subsidiaries.
    Of the total banking assets, the public sector banks hold around 70%, the private sector banks hold around 20% and the foreign banks, i.e. wholly owned subsidiaries or branches of foreign banks hold around 10%.
    Most of the public sector banks are listed and the government and government agencies hold around 60% in them directly. There’s a mix of holdings from insurance companies, mutual funds, and foreign institutional investors etc in small percentages. And the rest is holdings less than 1% of the total. So the government basically owns a very significant chunk of the commercial banking assets.
    Among the private banks I found that ICICI Bank and HDFC Bank, two of the country’s largest private banks have some significant foreign investment from Deutsche Bank and JP Morgan respectively (19% and 28%, I think). ING has a local mutation called ING Vysya Bank which is also a large private bank. ING have something like a 40% investment as a promoter.
    Other than that I don’t see any significant foreign investment in private sector banks in India.
    Reserve Bank of India announced increase in limits on external commercial borrowing, especially in the infrastructure sector, so capital controls aren’t that hard.

  • Posted by Chidam

    The Iceland story reinforces my point that once an economy goes through a crash landing the biggest banks go bankrupt. With a little bit of equity capital, it’s possible to buy large percentage stakes in banks, and once the crisis is over if those banks are going to dominate the financial system, the bet pays off in a very big way.
    I studied the Iceland story from the perspective of holdings in the largest financial institutions and found a typical pattern where a very few people were holding most of the equity in the financial sector before the crisis. Also their Net International Investment Position shows large outflows to FDI in various sectors in the UK, and in Eastern Europe.
    Their crash was driven by the unwinding of the yen carry trade and all the big Icelandic banks have been nationalized. The country was bailed out with a Euro loan from Russia and no other European country was willing to help them. They were very highly leveraged and large deposits from the UK and elsewhere were stuck in Iceland at the time of the crash.
    Post nationalization the ex majority shareholder of Landsbanki Islands was bidding for the UK assets of the bank in October, don’t have the latest on that.
    The story is that Iceland was just a Nordic hedge fund Halloween-masquerading as a little country of its own. And that the equity flow to them was from Russian Mafiosi.

  • Posted by credulous_prole

    Chidam:

    i’ve been following paulson’s work in China, too. The goal is to bring Chinese banks into the fold. I (ineptly) write about this on my blog.

    With Chinese deposits at its disposal, the Fed can really start having some serious fun!

  • Posted by Chidam

    @credulous:
    The latest thing I heard is that the direction of China’s trade policy might be to become a global destination for exports, rather than continue as a global source for imports. This is based on interpreting their trade negotiations with various South American and African countries.
    I read a report from an East Asian specialist in the Congressional Research -Foreign Affairs division. There’s a lot of bemoaning of China not disclosing details of their foreign aid programs.
    It’s quite a big topic with a lot of information to absorb. We have to see the current level of foreign direct investment in China’s banks and the break up to get further insight.

  • Posted by Twofish

    To Chidam:

    You still haven’t got to the part of the evil master plan that says “we make lots of money” or more accurately “I make lots of money.”

    Chidam: If any economy goes through a hard landing, a bulk of their banks will go bankrupt and that creates an opportunity to buy out big stakes in their commercial banking system with very little equity investment.

    This is not true. If the banks are well capitalized and well regulated then when the economy goes through a hard landing, then they have enough reserves to withstand non performing loans. The fact that you have banks blowing up in the United States is what happens when you don’t have good regulation. The Chinese government has been forcing the banks to have good balance sheets ever sense 1998 and the fall of Suharto.

    Also what’s the point in buying a bankrupt bank unless there is some synergy like a branch network? You can buy a house really cheap after burning it down, but what is the point?

    Chidam: With a little bit of equity capital, it’s possible to buy large percentage stakes in banks, and once the crisis is over if those banks are going to dominate the financial system, the bet pays off in a very big way.

    Or the crisis could get worse, at which point you lose everything which is what happened to the private equity investors of WaMu. Also, “dominate the financial system” doesn’t mean “make a whole lot of money.”

  • Posted by Twofish

    Eurasian: It is still a mystery to me how there could be so much appetite for writing CDSs on mortgage based credit risk.

    The reason for this is that with CDS, you can create “synthetic CDO’s.” A CDO is an instrument of say 100 bonds, that will pay the amount that say the 90th to 100th bonds. If you want to create a CDO but don’t want to bother buying real bonds, you can create one with CDS’s. Why create synthetics? It turns out that if you create a synthetic CDO, you can get a rating agency to stamp a AAA on it, at which point a bank or pension fund can use it as reserve capital.

    The big problem with CDS’s is this. A CDS trips….

    A owes B a huge amount of money
    B owes C a huge amount of money
    C owes A a huge amount of money

    Now after you settle, it turns out that everything cancels out and no real money changes hands.

    Now lets run the scenario again, and this time B goes bankrupt and can’t pay C. You have a huge mess.

  • Posted by Euraussian

    Twofish,

    Yes of course, I know that. Still, you would expect someone in AIG for instance to pay attention to the potential for trouble. Not to mention the risk managers in the IBanks. The more I think about the current crisis the crazier it becomes. My crises run from the early 1970s and this one is the weirdest. Almost like it is a sort of myth (booms tend to be based on myths, but busts usually not.. Think

  • Posted by anon

    “CDS were a way of making leveraged bets on credit (writing insurance in the expectation you wouldn’t need to pay = easy way to gear up — it was effectively a way of borrowing to buy a bigger portfolio of risky bonds)”

    A bit confusing. Alternatively, you might say it was effectively a way of getting exposure to a bigger portfolio of risky bonds without borrowing.

    It’s equivalent to explicit short put option risk exposure instead of funding an asset with embedded short put option risk exposure.

  • Posted by Twofish

    Eurassian: Still, you would expect someone in AIG for instance to pay attention to the potential for trouble.

    When people are making mega-bonuses the people that sound warnings are terribly popular that threaten those bonuses aren’t hugely popular.

    There are places where people did have decent risk management and didn’t get overexposed, but all you need is are a few places that didn’t, and that can overturn the apple cart.

    It just like leaving $100,000 in small unmarked bills in the middle of Grand Central. Yes, you might have a dozen walk by and not take the money, but to expect everyone to walk by is just unrealistic.

  • Posted by adiemuso

    twofish,

    exactly the point..unless the different owners and sellers of CDS n CDOs n all the other synthetic/financial alchemies can come together and agree, to write off, we will be stuck with such “paper” losses which drives companies and banks to bankruptcy.

    but problem is, we are in a war of man against every man, such altruistic “commonsensical” consensus is highly unlikely..

    once funding for corporates are decided upon CDS+X00BP…u noe its dead..its all wrong now..we are facing a collapse of cards..

  • Posted by df

    great post

    ndk writes
    “Chindia’s debt-to-GDP is vastly lower, around 60%, and they have plenty of room to maneuver. Here’s deeply hoping that Chindia gets religion, and soon.”
    This is utterly false. Chindia debt to GDP is over 200%, the figures you give are national debt to GDP. Sth completely different.
    Goverments of Chindia may want to add debts but private agents over there, just like any where on this planet are curbing on their demand for credit.
    Deleveradging of private agents globally is key to the process going on.
    I ve been explaining this for 4 years now.

  • Posted by Movie Guy

    Brad and others,

    Appreciate the CDO and CDS discussion.

    Yes, I have a general understanding of why the CDOs were written. Twofish explains the problem (if a problem occurs).

    My question is whether the Fed and U.S. Government should be involved in operations (facilities) that, for all practical purposes, shores up the CDS payouts. The apparent implication is that the Fed decided that the CDS positions of the borrowers (big investment houses) had to be covered in order to free up credit flows. Was that the right course of action?

    There are a number of ways to view the problem.

  • Posted by madmilker

    People in America need to realize jus what got America in this shape…”cheap” yes so-call cheap items from a foreign land.

    quote*Wal-Mart firmly believes in local procurement. We recognize that by purchasing quality products, we can generate more job opportunities, support local manufacturing and boost economic development. Over 95% of the merchandise in our stores in China is sourced locally. We have established partnerships with nearly 20,000 suppliers in China. *end quote!

    Now! if there be 182 country’s making items for the world to buy and they have only 5% of the pie in China…duh! This company makes the nice people of China support their currency(yuan) by keeping it in their country working for the people there…. but with the “yuan” going up in value and the US dollar going down…all the foreign items that the American consumer buys thinking it is cheap has went up in price.

    People…its all about the currency and to keep a currency strong you got to keep it floating around the country you live in so it can work for you. For the past 12 years all them US dollars are being shipped overseas to a foreign bank and with the American worker not making anything for the foreigner to buy the “we the people” have to turn to the “second” largest employer in America(Uncle Sam) to sell “we the people” debt in order to get all them dollars back!

    50 years ago a foreigner would had given their left nut for a US dollar or a Hershey’s chocolate bar and today the same foreigner has got Uncle Sam and the American consumer by both all the while Hershey is moving the chocolate factory to Mexico. Wake up! America and think “MADE IN AMERICA.”

  • Posted by shridhan

    Shridhan Automation is a Manufactures, Exporters & Suppliers a wide variety of Level switches, Level switches for liquids and Level Transmitters for liquids in India.

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