What if distress selling of RMB-denominated assets for repatriation to repay USD-denominated debt causes the hot money outflows to surpass the current account surplus?

Would we not see a downward pressure on the peg? If so, would not US treasure purchases exacerbate the devaluation pressure? So rather than increasing its USD holdings, the Chinese central bank would be obliged to sell off US T-bills to defend the peg.

And yes, gray income is a very powerful disincentive because it erodes a significant portion of incipient capital upfront with no guarantees whatsoever that the pigs won’t come back for more in the future. Let me ask you a question: would you invest in a mutual fund that has a front-end load of 5% and discretionary management fees of 5~10%, or one with .5% and minimum management fees? Please don’t say this is hard to decide.

We shredded the World Bank report over at CR a month ago, and rightly so. As I pointed out, the absence of a treatment of transportation and energy was key. In the last crisis these were the two main indicators that we wanted and couldn’t get!

I was there, it was real, and we all fed in from our cosy appts in Ta Yuan.

Hao ji le!

Regards

C

No I’m not arguing that. I’m saying that holding liquidity reduces risk, by reducing the chance of a risks *when* a bank risks becoming insolvent.

Observer: What we know is that China isn’t the only economy that has tried to gear growth towards a particular type of industrial policy, yet I don’t hear you exalting the virtues of the Japanese banking regulators or Korean regulators.

Because Japan and Korea are different from China. In particular one reason I think China has been successful is that it doesn’t have much in the way of an industrial policy. There is nothing in China like the Japan’s MITI or Korean chaebol. Also I don’t say very many good things about Japanese banking regulators because they aren’t very good. Don’t know that much about Korean banks.

Also, I don’t think industrial policy is a very good thing since it leads to micromanagement and distorted incentives. The reason I look very carefully at banks is that on the whole, they end up making the decisions about who gets credit and who doesn’t in a way that the government really has difficulty doing.

The problem here is that I think you are insisting on putting economies into two groups, whereas things are more complex. You can see examples in history of good state involvement in the economy, you can see examples of bad state involvement. Similarly state non-involvement can be either a good thing or a bad thing.

One other point is that things change. The Soviet Union and Japan had large amounts of growth in the 1950′s and 1960′s by huge amounts of capital investment and urbanization. This growth end in the 1970′s so by the 1990′s, both economies had major problems. Right now China is more like Japan-1950 than Japan-1990, so it isn’t a bad thing if China did massive amounts of capital driven growth as long as it realizes that it is probably going to end around 2020, and that it spends the time preparing for the transition.

It’s really easy to live in a two shade world. You can divide everything into “good” and “bad.” My problem is that the world is very complicated. So when I look at the similiarities and differences between the Japanese and Chinese banking systems, I have to go into some excruciating detail, rather than just label “good” or “bad.”

The evolution of the Japanese financial system over the last 100 years is very interesting. One of the more interesting things is MacArthur imposed in Japan in the late 1940′s a banking and industrial system that was American. But after the occupation troops left it didn’t take very long for it to evolve into something quite different.

What we know is that China isn’t the only economy that has tried to gear growth towards a particular type of industrial policy, yet I don’t hear you exalting the virtues of the Japanese banking regulators or Korean regulators.

But being insolvent doesn’t kill a bank. It’s when people show up at your door step wanting cash that you don’t have that you are dead. You can run an insolvent bank for years as long as you have the cash to pay out withdrawals.

Observer: The only advantage that the Chinese banks enjoyed is that the government is the shareholder, and thus the banks don’t have to worry about raising equity.

1) Commercial banks in the US have lines of credit with the Federal Reserve. Investment banks didn’t, that’s why they’re are no more commercial banks in the United States.

2) Also Chinese banks did have to worry about moral hazard issues in the end. If the Chinese government just wrote a check every time a bank needed money, then it would go into a black hole, and eventually the government would run out of money.

So you have to think long and hard about how you recapitalize the banks, because you if you do the wrong thing, you will end up having to write check after check after check. This means that it is extremely important that you have time to think.

3) The US government has the power to seize an insolvent bank and has done so (Washington Mutual). Depending on how bad things get, the government may end up nationalizing large parts of the banking system this year. One you reach a certain point then nationalization becomes inevitable.

If people think that the government is going to take over a bank, then no private investor is going to put money into that bank because their shares are going to be diluted, and at that point the only one that can put money into a bank is the government.

We aren’t quite at that point yet, but we aren’t that far away from it.

In the case of TARP, there was a massive crisis and the US government didn’t have time to think about what to do. Right now something will have to be done about the commercial banks, but we have a few weeks to think about what that thing is.

Observer: If that’s a necessary disadvantage for private markets, so be it.

Personally, I don’t care whether the economy is private, public, some mix of the two, neither, both. I just want something that works. It seem obvious to most people that the system in place over the last eight years doesn’t work. The hard part is figuring out what to do about it.

Observer: But don’t confuse the Chinese government’s credit line as a sign that inefficiency works better. It doesn’t.

If you get 1% more GDP growth for five years, and then lose it all in a banking crisis, then the system is broken. Also, one thing that has become clear is that bank require some government credit line which is why all banking institutions in the US now have them. Once the government extends a credit line, then the government and the taxpayers are going to demand some control over the management of the bank, which is also what is going on.

So at this point the US banking system no longer is anything like a private market system any more (and really the US banking system hasn’t been a private market system since at least 1933).

It doesn’t matter how much cash you are holding. You can have 100% of your holdings in cash, but if the value of that cash in a particular currency drops down to less than the liability, then you would still be insolvent.

The only advantage that the Chinese banks enjoyed is that the government is the shareholder, and thus the banks don’t have to worry about raising equity. If that’s a necessary disadvantage for private markets, so be it. But don’t confuse the Chinese government’s credit line as a sign that inefficiency works better. It doesn’t.