Between the holiday slowdown and the number of writing commitments I have it has been a little too easy to neglect my blog. What free time I have has been spent reading, and I am reading for the third time what I think is one of the best books ever written on financial history – Barry Eichengreen’s Golden Fetters: The Gold standard and the Great Depression.
Eichengreen’s book has an awful lot to tell us about our own current crisis, as does any good book on financial history. In spite of all the unending nonsense written about what went caused the financial crisis this time around – derivatives, securitization, deregulation, greedy bankers, overpaid traders, fraudulent behavior – the fact is that financial crises going back over at least 2000 years are disconcertingly familiar, and have nearly identical consequences and processes, even when they include none of the conditions blamed for the current mess. To focus on those particular triggers as being the main causes of the crisis is what I would call the “trigger fallacy.” They are merely the symptoms of the underlying problem – excess liquidity, which the financial system is forced into accommodating by taking on increasingly levels of risk, either inside or outside the regulated areas.
Not surprisingly then it is impossible to read Eichengreen’s book in the current economic climate without several “aha!” moments, but this passage (pp. 11 of the 1992 edition) I found particularly interesting:
The arrival of the Fed on the international scene was a significant departure from the pre-war era. Disputes between New York and Washington rendered the new institution unpredictable. Until the Banking Act of 1935 consolidated power, considerable influence was wielded by reserve city bankers from the interior of the country with little exposure or sympathy for international considerations.
Eichengreen is discussing how the advent of the US as a major financial center changed the “rules of the game” involving cooperation between the major European central banks – mainly the UK, France and Germany – when the closest thing to a US counterpart was the very well-managed and internationalist House of Morgan. During the end of the 1920s and beginning of the 1930s the Fed’s role became increasingly prominent and increasingly erratic especially after the death of Benjamin Strong, who ran the New York Federal Reserve Bank and who had a very strong relationship with Montagu Norman, the Governor of the Bank of England.
The point is that before power was consolidated under the Chairman of the Federal Reserve System in Washington DC, the US central bank consisted of 12 regional banks with quite a lot of independent power, and the regional banks tended to be, not surprisingly, more parochial, more beholden to the dominant economic interests of their region, less understanding of the US role within the global system, and less sympathetic to the need for the US to behave in a manner befitting what was later dubbed a “global stakeholder.”
This had consequences. It was very hard for the US central bank to act in a consistent way to manage its proper role within the global context, and this failure not only created a very debilitating uncertainty, but also ensured that parochial interests trumped international interests even when the US was better off parochially from understanding its role within the international context. For example US trade policies aimed at helping regional economic interests at the expense of the outside world ultimately ensured both a collapse in international trade and, as result of the US position of overcapacity, a brutal collapse in US capacity.
What does this have to do with China? Perhaps nothing, but I am of course not the first to observe that the PBoC has very little independence and is largely beholden to the State Council and senior officials within the Standing Committee for its policy decisions. This is, in itself, not a problem and might even result in better coordination between the country’s treasury and central bank functions. However there are persistent rumors of serious disagreements among senior policymakers and especially a split between one camp, dominated by provincial leaders more concerned about social issues arising from unemployment and income inequality, and another camp, based in the major international center and more concerned about macroeconomic imbalances at both the national and global levels.
Is there a possibility that the PBoC will find itself, like the Federal Reserve in 1929-31, riven by very different understandings of the country’s role within the global crisis and with different priorities in resolving the crisis – ones that misconstrue how the global adjustment will affect China’s adjustment? I have no idea, and perhaps the game of finding parallels between 1929 and 2008 gets a little carried away at times, but it is worth considering that monetary policy-making in China has not always been consistent and, like most major policy-making, can be easily subject to competing views of Chinese political priorities and China’s role within the crisis.
This is not to say that the illusionary triumph of parochial over global interests is inevitable, as occurred in the US in the 1930s, but it certainly is a possibility. This is yet anther reason why I am convinced that US, European, Japanese, and especially Chinese leaders need to get a clear macro picture of what the global balance of payments adjustment will mean for each country, and give up the silly blame game to work out a reasonable long-term period (at least three or four years), during which time China can adjust to the global adjustment. Any quick adjustment will be bad for the world and devastating for China.
But the prospects for understanding don’t look good. Local newspapers are filled with worried articles about rising unemployment, and on Saturday Premier Wen made an unscheduled and very surprising visit to one of our academic neighbors. According to an article in today’s People’s Daily:
Chinese Premier Wen Jiabao has pledged to university student that the government would seek to provide more jobs for graduates and “put the issue of graduate employment first.” “Your difficulties are my difficulties, and if you are worried, I am more worried than you,” Wen told the students at the Beijing University of Aeronautics and Astronautics. Wen made the remarks in a surprise visit on Saturday afternoon.
…He said the country is in a difficult period as the global financial crisis has continued affecting the country’s real economy. The government has begun measures to sustain the economy, such as the four-trillion-yuan stimulus package and interests cuts. “We are considering taking more measures at proper time. But currently we are most concerned about two issues, migrant workers returning home and employment for graduates,” Wen said.
The financial crisis and China’s slowing economic growth has forced 4 million migrant workers to return to their rural homes, according to a report from the Chinese Academy of Social Sciences. The report also said as of the end of this year, 1.5 million graduates are likely to have failed to find jobs, and the country could see an ever tougher employment situation in 2009 as there will be about 6.1 million seeking jobs (from 5 million last year).
Other headlines fret about the mass migration – well before the traditional Spring Festival period – of unemployed workers returning to their rural homes. According to an article in Friday’s South China Morning Post:
Up to 9 million migrant workers have left coastal areas this year amid diminishing job prospects and falling wages, prompting fears that unemployment in inland provinces may increase sharply next year. Home-bound migrant workers have packed major railway stations in major cities, catching the central government by surprise because the traditional passenger peak arrives just before the Lunar New Year, which is late next month.
There is still more about the rise of criminal gangs, more protests, and all the other indications of social tension. In these circumstances it is not hard to see why policymakers may decide that short-term unemployment pressures trump the global balance of payments adjustment, and push to subsidize and encourage more production, rather than worry about rapidly expanding domestic consumption. This would, of course, only exacerbate the Chinese overcapacity problem and increase the likelihood of trade tensions which, if they lead to global protectionism, could scuttle any chances of China’s recovering from the crisis. I guess this is exactly what they mean by “between a rock and a hard place.”
One other thing to discuss before I finish this long posting – Bloomberg posted the following article today:
China’s foreign exchange reserves dropped for the first time in five years as a result of the global financial crisis, Market News International reported, citing Cai Qiusheng, head of the investment management bureau under the State Administration of Foreign Exchange. The current figure must be lower than the peak of about $1.9 trillion, Cai told a trade forum in Beijing over the weekend, the English-language wire service said. He didn’t specify which period he was referring to or give a figure.
I am not really sure what is going on. We used to get regular and reliable monthly leaks about reserve figures but these have pretty much dried up since June, just as we needed the numbers more than ever. The last official numbers were released for September – they are released on a quarterly basis – and put reserves at $1.9056 trillion. The latest “leak” claims reserves are at $1.89 trillion, which with rounding suggests that reserves declined in two months by somewhere between $10 and $20 billion.
Of course we are all very eager to get a better breakdown of the recent figures so that we can estimate hot money flow directions. But given the we have had two world-record-smashing trade surplus months in a row since September, amounting to $75 billion (and three monthly world records before that), not to monition positive FDI inflows of $14 billion and about $10 billion of interest income in the past two months, it is very unlikely that the dollar value of the various non-dollar reserves can have declined by even a significant fraction of $99 billion increase in reserves from trade, FDI and interest income in the past two months (or the $110-120 billion implied by the new reserve numbers). Does this mean there has been significant hot money outflow? Perhaps, but without real numbers it is tough to want to conclude anything. January’s central bank data release promises to be very, very interesting.
But there’s more. My friend Victor Shih published a very good Op Ed article in the Wall Street Journal Asian last week. You can find it on his blog. He discusses how the new fiscal expansion plans – which are seriously constrained by structural impediments in the economy – are likely to cause significant pressure for bank “participation,” and this pressure is unlikely to lead to improved banking practices. He concludes:
In any event, everyone is too preoccupied with their own losses to comment on Chinese policies. Which is a problem, not least for China itself. With enormous political pressure from the central government to pump money into the economy and silence from the rest of the world, much of the work in the past decade is being undone.
What will happen to all this money? Stephen Green – one of the best bank research analysts on China, in my humble opinion – just published a research report called China – The best-laid plans of mandarins and ministers in which he tries to tabulate the various spending plans being proposed at the national and provincial levels. Not surprisingly, he has a hard time figuring out the numbers – one section of his report is titled “CNY 4trn, CNY 18trn, or CNY 320bn?”
The government is so worried about a slowdown that there is almost a feeding frenzy over who can proclaim the most spending – with very poor Hunan proposing $1.2 trillion in expenditures that surpass the entire US fiscal plan, as Green notes. Even if most of these proposals are rejected, clearly an awful lot of money is going to be spent awfully quickly with an awfully small amount of oversight. Elsewhere in the report Green notes:
One suspects that corners are now being cut to get the money flowing again. The bureaucracy must also be exceedingly happy; it is commonly believed that 15-30% of the cost of a project is absorbed by ‘administrative’ fees, ‘consultancy’ fees, and the like (which raises the question of whether we should be discounting the CNY 4trn by 20% or so, and assuming these other funds will form part of 2009’s FX capital outflows). The Party’s corruption inspectorate is already preparing teams to monitor the use of public and bank funds. But it is, as they say, a big country.
It certainly is. And yes, we should be increasing our estimates of hot money outflows next year.
Happy holidays to all my readers. Unless there is a lot of important news in the next few days I will probably not post anything for a week. For those living in Beijing, we do have an outstanding Christmas Eve show at my music club, D22, and another outrageous night on New Year ’s Eve. If you want a good feel for some of the best new music in China (and the world), don’t miss these two nights. Sorry for the advertisement, but the Beijing music scene is truly exciting.
Thanks for the blog Michael – have a great Christmas and a Happy New Year!
Your advert showed another side of you I wouldn’t suspect from reading this blog
I found this:
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aMObwO4kn4SE
Amongst other articles on a search of “pettis d22″. Wish I’d known when I was there last!
–Q
Well, if “what’s past is prologue” wouldn’t be surprised to see a leaf taken from the Singaporean/Israeli example and have all those fresh graduates conscripted for a couple of years while the dust settles! After all, that’d help beef-up the forces to control any unrest … and detract from those that might cause it!
Micheal,
I am so glad to have stumbled across your blog. Your insights contain a wealth of information.
Reinforcing your thoughts are China’s recent laments for the world not to restrict ‘free trade’. I myself think that it is inevitable for a new definition on what exactly ‘free trade’ is to emerge. There is no sustainability to the current mercantilist practises that have distorted markets. The US could correct them with a 42% (Navarro – China price report) import tax on goods from China. This would generate tax revenue for the US government, add inflationary stimuli and provide a chance for increased employment within the US.
One issue that I have not seen addressed is the potential for other countries that are or have practiced mercantilism is to grow resentful of China’s volume of US treasury purchases (as a means to manipulate exchange). I would think that Japan is not to happy with the eventual dilution in value that must occur in their holdings of US dollars as a result of China’s actions.
Thanks for the work you do on the blog, and may you have a wonderful holiday!
Cheers.
It seems to me we built the engine of globalization with an implicit belief in market fundamentalism, which means that the speed of globalization basically outstripped the speed of institution building and the development of shared values. Now we see that these things matter.
I am skeptical that globalization as it currently exists can be maintained. It must go through a period of collapse. There simply is no regulatory structure or common set of values. Accountability of govts to their people will push them into economic conflicts with other countries. Of course, this is already beginning to happen.
We have a version of globalization which is unmanageable. It is too complex, too interdependent, and ungovernable.
The problem is that serious thought about managing the global economy has been given very short shrift, due to free market ideology. In terms of ideas, we are far behind the curve, leaving us to be mere victims of unfolding historical processes.
In the long run, the good news is that this is happening before environmental collapse. Surely any regulatory structure that could govern global economic integration would also include environmental regulation.
Happy holidays. Would love a recommendation of new music that I can buy here in the USA. Also, would love post on China-rest of Asia, China-Russia trade. I can read a growing number of articles on the China-USA or China Europe trade but not these other areas. It seems that protectionist tendencies will appear first in these other areas. How important is that trade and what is the likely Chinese response to protectionism.
Thanks for a year long education.
Merry Christmas Prof. Pettis and thank you for this blog entry.
In view of this entry can you comment about the latest news on the decrease of China’s foreign reserves:
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http://uk.reuters.com/article/marketsNewsUS/idUKPEK29524820081222
BEIJING, Dec 22 (Reuters) – China’s foreign exchange reserves, the world’s largest stockpile, shrank in October to less than $1.89 trillion, their first monthly fall since December 2003, a source familiar with the situation said on Monday.
The reserves stood at $1.906 trillion at the end of September, the last date for which official figures have been reported, meaning they fell by at least $16 billion during October.
The source, who wished not to be identified, declined to say whether the reserves continued to fall in November.
[...]
China’s trade surplus hit consecutive record highs in October and November, of $35.2 billion and $40.1 billion respectively, as the slowdown in import growth outpaced that of exports.
[...]
In the third quarter of 2008, the last period for which figures are available, the reserves increased by less than the sum of the country’s trade surplus and foreign direct investment inflows during that period — a very rough indication of whether the country has witnessed capital inflows or outflows.
__________________________________________________________
Is this a simple result of “hot money” finding a domestic recycling, a sign that private currency reserves are moving towards expanding the informal banking sector?
Or is it a sign that, on the background of dwindling profit margins of Chinese exporters, there are not enough money left for both subsidies and dollar sterilization of the trade surplus?
“The years 1843-5 were years of industrial and commercial prosperity, a necessary sequel to the almost uninterrupted industrial depression of 1837-42. As is always the case, prosperity very rapidly encouraged speculation. Speculation regularly occurs in periods when overproduction is already in full swing. It provides overproduction with temporary market outlets, while for this very reason precipitating the outbreak of the crisis and increasing its force. The crisis itself first breaks out in the area of speculation; only later does it hit production. What appears to the superficial observer to be the cause of the crisis is not overproduction but excess speculation, but this is itself only a symptom of overproduction.”
http://www.marxists.org/archive/marx/works/1850/11/01.htm
The problem with the thesis of parochial local interests killing the Federal Reserve is that the Federal Reserve System only started to exist in 1914. The decentralized structure of the Federal Reserve was intentional as something of a political compromise because there is no way that a system that was dominated by “East coast banking interests” would have been acceptable to the mid-West farmers that wanted a very loose monetary policy. Before 1914, the US had no central bank, and the defacto central bank was JP Morgan, which was something that mid-Western rural interests did not like.
One problem that I’ve seen in people with academic backgrounds is that they tend to be extremely dismissive of “special interests” that get in the way of their grand visions of how society is or ought to be structured. The trouble is that often those grand visions turn out to be completely unworkable in part because they fail to consider that people *do* have parochial interests and part of the purpose of a political and social system is to figure out how to satisfy those interests.
Personally, I tend to be extremely skeptical of policies based on mono-causal explanations of social events, because those policies often turn out to be disastrous if those explanations are wrong, which they often are.
Pettis: However there are persistent rumors of serious disagreements among senior policymakers and especially a split between one camp, dominated by provincial leaders more concerned about social issues arising from unemployment and income inequality, and another camp, based in the major international center and more concerned about macroeconomic imbalances at both the national and global levels.
That’s hardly surprising since you have exactly the same dispute within the United States in the late-19th century over the issue of a gold standard or a silver standard. What matters is not so the dispute, but that you have a political system that is strong enough so that the dispute doesn’t keep things from getting done.
I really don’t see what Victor Shih is worried about. If the government wants a bank to make a loan and the government is willing to either guarantee the loan or provide the capital for the loan, then there is no issue of risk management for the bank. All the risk managers have to do is to get that sheet of paper saying “The Central Government promises to cover the loan if it goes bad” and it’s no longer the bank’s problem.
The other thing about risk management is that you can properly risk manage things not only by decreasing risk but increasing loss reserves. It’s perfectly fine to lend to risky clients if you have the loss reserves to cover defaults.
Also his article makes it seem like the only reason that Chinese banks fixed themselves was Western pressure, and now that pressure is gone, that the government will backslide. In fact, the reason the Chinese government has spent the last ten years fixing the banking system was because they were (and still are) terrified of a banking crisis that would bring down the government.
Recent events haven’t reduced this fear, and pointing out that Chinese banks aren’t collapsing when American banks are, should be enough to keep banks doing good risk management.
If Westerners want Chinese banks to have good risk management, the thing to do is not to lecture and instead say “look you guys are geniuses and we are idiots, study what we did over the last ten years and whatever you do, don’t do the same things, but rather keep doing what you were doing.”
[...] Notes on the Chinese banking system Filed under: china, finance — twofish @ 3:27 am http://mpettis.com/2008/12/can-parochial-concerns-undermine-the-global-adjustment-it-has-before/ [...]
[...] Can parochial concerns undermine the global adjustment? It has before Michael Pettis (hat tip reader Michael) [...]
Find where the demand is and send it there. Why would not China be interested in building more efficient railroads/roads/communities in anticipation of the next wave of global prosparity. Would that not keep unemployment at bay and raise the standard living of their own people? Where is Frank Lloyd Wright and his planned communities when you need him? Happy Holidays everyone!
Great Blog and Merry Christmas, Happy Holidays!
YASHENG HUANG is a professor of international management at the MIT Sloan School of Management and the author of “Capitalism with Chinese Characteristics” (Cambridge University Press, 2008)…he wrote in the WSJ on Sunday…succinct piece that cuts to the heart of China’s problem and highlights quite a bit of what Prof. Pettis seems to be speaking to.
http://online.wsj.com/article/SB122988679995424611.html?mod=rss_opinion_mainu#printMode
China is in deep doo doo. Can you imagine central planning trying to deal with this kind of problem? I don’t think the Feds will do much better!
The purported “regional” structures of the Federal Reserve System are now and have always been a facade to mask the fact that the Fed is run out of Washington and Wall Street. Ron Paul has it right — the Fed should be abolished. While it pretends (although not at the moment) to fight inflation, it is now, and always has been, in the business of inflation. A 1913 dollar is now worth a nickel. All of our current imbalances are the legitimate offspring of this absurd system.
[...] That’s what happened with US vs. UK in the 1920-1930s. Do you think the Chinese can commit the same mistake as Roosevelt did, as professor Michael Pettis, from Guanghua School of Management, Beijing University, recently [...]
I happen to disagree with just about everything that Yasheng Huang has ever said about the Chinese economy. First of all, we won’t know for other year how well or badly the Chinese economy reacts to the recession, but my assertion is that it will do relatively well, because there is enough cash cushion in the economy to keep a crisis from happening, while people figure out what to do next.
I think part of the reason is that he comes from a management background and I come from a finance one, so what he sees as inefficiency, I tend to see as prudence. Also Huang sees the 1980′s as some sort of golden age, an idea I find flawed, since a lot of the reassertion of government control in the early 1990′s happened when a lot of the credit institutions of the 1980′s went broke.
In the case of Chinese wages, a lot of GDP growth hasn’t been put into wages, but they have been put into 1) paying off the transition from central planning to the market 2) making sure that the banks and the corporations are very well capitalized so that they can withstand economic shock and 3) building up factories so that the economic won’t collapse when everyone retires. These three items are quite costly, and so by increasing GDP, you are able to pay for these things while keeping wage growth relatively high. If you try to reduce production while keeping wages high, chances are that you will end up reducing risk reserves which makes the entire economy more vulnerable to economic shocks.
Also if supply is more than demand, the solution isn’t to cut supply but boost demand. You can do this in a number of ways, of which increasing consumption is only one of them. You can boost investment or else boost government spending.
Also the problem with land is that both in the US and in China, you end up with land being bought not at the “fair market price” but the “bubble price.” If you try to make farmers rich by selling land to developers, you end up with the same thing happening as in the United States, that wealth comes from the banking system which means that you end up with a larger crisis when everything falls apart. Also, if all else fails, peasants with land can go back to farming it. Once the peasant no longer has title to agricultural land, it’s not clear what happens to the peasant if everything falls apart.
Twofish.
I can not see how the Chinese government can buffering itself from a huge shock from the slowing of the investment/export.
The liquidity and the cash will go out on the window quickly, simply because the real cushion is the customer spending and the service sector.
I think that the future events in China will be very similar to the system change in eastern Europe.
This will be the breaking point.Eastern Europe was unable to do this kind of change due to the high level of industrialisation.But you can not save the pain of the political change.
Chinese banks showing signs of rejecting any positive effects of recent fiscal stimulus.
http://www.eeo.com.cn/ens/finance_investment/2008/12/25/125035.shtml
“We won’t approve loan to such railway projects. Financial support from local governments would only be a one-off thing. Whether the project can handle repayment in future depends on its operations,” said a banking official…
bomlat, nothing major will happen in China. Unlike Eastern Europe in the late 80s, the Chinese government has enough cash at hand to quell any labor related unrest.
I wonder why the Chinese government did not allocate enough funds in the stimulus package for the health care and education service sectors. Maybe it will be in the 2nd stimulus package.
Regarding unemployment and the ‘mob’ of fresh graduates coming on to the market … this below from the China Daily, Jan 8:
College graduates who take jobs in central or western China will be entitled to a full refund of their tuition fees, the State Council said Wednesday.
The refunds will be paid to all graduates who find employment in towns and villages in central and western China, or in other remote areas of the country, it said.
Those who join the army will also be entitled to the payments, it said.
http://www.chinadaily.com.cn/china/2009-01/08/content_7376464.htm
Its certainly an idea that’s a lot better than straight out conscription.
Nations are suffering the disintegration of governments due to the lack of understanding of their meaning in a global society.
Mankind’s evolution has set the parameters that rule the governments they deserve, but sometimes not in phase with the times.
The industrial and technological evolution has overtaken mankind leaving it remnants of the benefits and most of the responsibilities.
Native man is struggling to survive against the immense disadvantage he has, due to an unfair valuation of his energy output versus the competing artificial energy production.
To equalize this disparity, I suggest that government’s income be only from taxes on energy consumption, massive and controllable fuel and electricity. This permits to abolish all other taxes as to free man from government and permit him to thrive from a primitive native position to a modern intellectually complex being.
This would create a free market and a mirror image free government, that symbiotically could indefinitely coexist.
*****
End of economy, beginning of energonomy. No longer will you be retributed by a sweatless salary but by one that shows the sweat produced by you at the job. Simply you cannot be a job bystander, you must put your soul and will to your lovely mistress, your job, otherwise someone else, nearby or overseas will. End of currencies with economicist’s values, Dollars, Euros, Francs, Marks, etc.-, beginning of Bioenergo and Artenergo, human and artificial energy values, respectively, and regulated by Energos, a ratio of these energies.
Energos = Bioenergo / Artenergo
Your activity will be measured in Bioenergos and Artenergos and paid in each country’s certificate. An Energo ratio will be calculated for each activity and product, and for the business interchange ratio between nations. Bioenergo will the value of human work units and Artenergo will be the values of artificial energy. Developed nations will generate lower index values and underdeveloped nation’s higher Energo values. This will expose the disparity between them as to promote politics attenuating these differences, protecting the weaker from the stronger, as to equalize all people’s wellbeing.