Perhaps because I started my career in 1987 trading defaulted and restructured bank loans during the LDC Crisis, I have spent the last 30 years as a finance history junky, obsessively reading everything I can about the history of financial markets, banking and sovereign debt crises, and international capital flows.My book, The Volatility Machine, published in 2002, examines the past 200 years of international financial crises in order to derive a theory of debt crisis using the work of Hyman Minsky and Charles Kindleberger.

No aspect of history seems to repeat itself quite as regularly as financial history.  The written history of financial crises dates back at least as far back as the reign of Tiberius, when we have very good accounts of Rome’s 33 AD real estate crisis.  No one reading about that particular crisis will find any of it strange or unfamiliar – least of all the 100-million-sesterces interest-free loan the emperor had to provide (without even having read Bagehot) in order to end the panic.

So although I am not smart enough to tell you who will or won’t default (I have my suspicions however), based on my historical reading and experiences, I think there are two statements that I can make with confidence.  First, we have only begun the period of sovereign default.

The major global adjustments haven’t yet taken place and until they do, we won’t have seen the full consequences of the global crisis, although already Monday’s New York Times had an article in which some commentators all but declared the European crisis yesterday’s news.

Just two months ago, Europe’s sovereign debt problems seemed grave enough to imperil the global economic recovery; buy cialis online.Now buy cialis online, at least some investors are treating it as the crisis that wasn’t.

The article goes on to quote Jean-Claude Trichet sniffing over the “tendency among some investors and market participants to underestimate Europe’s ability to take bold decisions.”  Of course I’d be more impressed with Trichet’s comments if pretty much the same thing hadn’t been said before nearly every previous crisis. Before the decade ends, I am pretty convinced, there will be several countries, including European, struggling with the process of debt restructuring, and some of the victims will surprise us.

The second statement I think I can make with some confidence is that there is no threshold debt level that indicates a country is in trouble.  Many things matter when evaluating a country’s creditworthiness.

As a rule anything that increases the chance of a sustained mismatch between earnings and debt servicing undermines the creditworthiness of the borrower.  But what really matters is not the expected outcome so much as the probability of an extreme outcome.  The expected variance, in other words, is more important than the mean expectation, which is another way of saying that a country with less debt and more variance can be a lot riskier than a country with more debt and less variance.

What are the risk factors?

I would argue that there are at least five important factors in determining the likelihood that a country will be suspend or renegotiate certain types of debt:

1 – buy cialis online.Of course debt levels – perhaps measured as total debt to GDP or external debt to exports – matter.  As a general rule buy cialis online, the more debt you have, the more difficulty you are going to have servicing it.

But we shouldn’t get too caught up in nominal debt levels.  Coupons matter too.  So, for example, as part of the Brady restructuring of the 1990s, most loans were exchanged either for “discount bonds”, which included an explicit amount of debt forgiveness via a reduction in principle, or “par bonds” which included no explicit reduction in principle, but the coupon was reduced.

In fact par bonds and discount bonds implied the same real amount of debt forgiveness, but this debt forgiveness did not show up as a lower nominal debt level in the case of the par bonds.  It showed up as a lower nominal coupon.

This Brady-bond talk may seem largely academic, but it has a very important modern-day implication.  It means that financial repression also matters a lot – even though it gets little attention in discussions about sovereign credit risk.  In some countries, most notably Japan and China, interest rates are set artificially low – much lower than they would be by the market.  Local central banks can do this because the financial systems in these countries are heavily banked (i.e.most savings and financing occur through the banking system), there are few investment alternatives, and the financial authorities determine deposit and lending rates.

Forcing down interest rates in this way has exactly the same effect as the lowered coupons on the “par bonds” described above.  It implies significant (and hidden) debt forgiveness, so when we look at Japanese and Chinese debt-to-GDP ratios we must remember that we should conceptually reduce the nominal debt levels to reflect the fact that the interest coupon is artificially low – perhaps reducing nominal debt by as much as 30-50%.

This is why Japan was able to raise its nominal debt level to what seemed unimaginably high (and why if it is ever forced to raise interest rates to a more reasonable level, it will face real difficulty), and why although I believe China has a debt problem, I do not believe this problem will show up in the form of a banking or sovereign debt crisis (instead it will show up as lower consumption, as I explain in my July 4 post).

2.The structure of the balance sheet matters, and this may be much more important than the actual level of debt – buy cialis online. In my book I distinguished between “inverted” debt and hedged debt.  With inverted debt, the value of liabilities is positively correlated with the value of assets, so that the debt burden and servicing costs decline in good times (when asset prices and earnings rise) and rise in bad times.  With hedged debt, they are negatively correlated.

Foreign currency and short-term borrowings are examples of inverted debt, because the servicing costs decline when confidence and asset prices rise, and rise when confidence and asset prices decline.  This makes the good times better, and the bad times worse. Long-term fixed-rate local-currency borrowing is an example of hedged debt.  During an inflation or currency crisis buy cialis online, the cost of servicing the debt actually declines in real terms, providing the borrower with some automatic relief, and this relief increases the worse conditions become.

Inverted debt structures leave a country extremely vulnerable to debt crises, while hedged debt helps dissipate external shocks.  Highly inverted debt structures are very dangerous because they reinforce negative shocks and can cause events to spiral out of control, but unfortunately they are very popular because in good times, when debt levels typically rise, they magnify positive shocks.  I discuss this a little more below when I talk about virtuous and vicious cycles.

3.The economy’s underlying volatility matters. Less volatile economies can safely bear more debt because their earnings are less subject to violent fluctuations, especially if the performance of the economy is correlated with financing ability.  This is especially a problem for countries whose economies are highly dependent on commodities.  Not only are commodity prices volatile, there is a long history suggesting that global liquidity dries up at the same time that commodity prices collapse.

This is a deadly combination for highly indebted economies with big commodity sectors.  Commodity importers, however, benefit because their volatility is negatively correlated to market conditions (unless of course they have stockpiled commodity prices in a misguided decision to “hedge” themselves – effectively reinforcing inversion in their balance sheet).

It is possible to create a measure that adjusts debt levels according to underlying economic volatility.  The first academic piece I ever published, in 1993 I think, looked at 1975-80 external-debt-to-export ratios for a number of developing countries and found no predictive ability.  In other words if you had used these ratios back then to predict which countries would have defaulted on their external debt in the 1980s and which didn’t, you would have done no better than if you simply tossed a coin.

But when I used an option formula to adjust the ratios to incorporate the volatility of their export earnings, suddenly the predictive ability of the adjusted ratios became extremely good.  The more volatile the country’s export earnings, in other words, the more likely it was to default for any given amount of external debt.

4 – buy cialis online. Buy cialis online: the structure of the investor base matters. In my opinion contagion is caused not so much by “fear”, as most people assume, but by large amounts of highly leveraged positions (including leverage through forwards, options, and leveraged notes), which force investors into various forms of “delta hedging” – i.e.buy when prices rise, and sell when they drop.

This kind of trading strategy automatically reinforces price movements both up and down and spreads them across asset classes.  Highly leveraged markets are highly susceptible to contagion, whereas markets with little imbedded leverage almost never are.

5 – buy cialis online.The composition of the investor base also matters – buy cialis online.A sovereign default is always a political decision buy cialis online, and it is easier to default if the creditors have little domestic political power or influence.  Unless foreign investors have old-fashioned gunboats, or a monopoly of new financing, for example, it is generally safer to default on foreigners than on locals.  It is also easier to “default” on households via financial repression than it is to default on wealthy and powerful locals.

One corollary, by the way, is that the total value of assets owned by a government does not matter in determining likelihood of sovereign default as much as many might assume.  Governments are not subject to corporate or bankruptcy law.  In any individual country you will often hear optimists say that in spite of high debt levels the country will not default because the government owns more assets than it has liabilities.

You should ignore this argument.  This is muddled thinking on many counts (for example how easily can you sell assets in a liquidity crisis?), but rather than go into detail, let me just point out that throughout history defaulting governments have almost always had significantly more assets than the value of their liabilities (in fact I cannot think of any exception).

There is usually, however, a significant political cost to relinquishing those assets – that is usually why the government owns them in the first place.  If that cost is greater than the cost of default, the government will default.

Beware virtuous cycles

What does all this tell us about the probability of a country’s being forced into default or restructuring?  Perhaps not much except that tables that rank countries according to their debt ratios are almost useless in measuring the likelihood of default.  This would be true even if those rankings were accurate, but not surprisingly countries hide a lot of their real obligations, and the riskier they are the more likely they are to hide them, so the inaccuracy is always biased in the wrong direction.

It also suggests that investors really need to look very carefully into each country’s underlying economic volatility and, most importantly, the country’s debt structure, since the structure of the balance sheet, and the correlation between asset values and liability values, may actually be more important than the outstanding amount of debt.  Countries with a lot of short-term debt, external debt, and asset-lending-based banks, especially large amounts of real estate lending, are far more vulnerable than they might at first seem because the debt burden is likely to soar at the worst time possible – just when everything else is going wrong.

Lots of hidden and off-balance sheet debt is also a very bright red flag, because these structures nearly always implode just when economic conditions sour.  One of the main points of the IADB’s Living with Debt (2006) is that nominal debt levels just before a crisis often seem reasonable, but suddenly surge because of an unexpected (but easily predictable in retrospect) explosion in contingent liabilities.

In fact some of the recent “star” sovereign performers may very well be the biggest risks, since their great performance may have been caused in part by highly inverted balance sheets.  These kinds of debt structures ensure that good times are magnified, but they also ensure that bad times are exacerbated.

Remember this when someone argues that Country X is doing very well and has even locked itself into a virtuous cycle, in which a good event causes other good events that are self-reinforcing.  There are few things as risky as highly virtuous cycles, which are almost always caused by inverted balance sheets.  Many of my Brazilian friends, for example, wince whenever they hear about virtuous cycles, because they know first hand how virtuous cycles can quickly collapse into vicious cycles.

Until 1997, for example, Brazil’s biggest credit problem was its huge fiscal deficit, more than 100% of which was explained by interest payments on short-term debt.  As global conditions improved during the middle of the decade, Brazil was caught up in a powerful virtuous cycle.  The improving external position caused local interest rates to decline, which dramatically reduced the projected fiscal deficit, and so boosted confidence, causing interest rates to decline even more.

Inverted structures are toxic

It was wonderful – and happening very quickly – with real interest rates dropping from the 30-40% range to the 20-25% range in a matter of two or three years.  But the 1998 crisis set off a devastating reversal of that process.

A global flight to quality caused Brazilian interest rates to rise.  Rising rates dramatically pushed up the government deficit (the financial authorities had not bothered to lock in the low rates, believing that the game would go on until domestic interest rates were at an “acceptable” rate), which caused confidence to drop.  Declining confidence forced interest rates higher, and so on with the result that interest rates spiraled out of control as each event reinforced the other.  Brazil was forced into a currency crisis in January 1999.

It was a similar process for the countries participating in the Asian crisis of 1997.  During the early and mid 1990s it seemed obviously clever to borrow in dollars to fund local operations since dollar interest rates were much lower than local currency rates, and moreover the dollar was depreciating in real terms.  The more locals borrowed dollars and converted into local currency, the more local asset markets boomed and the lower the real cost of the financing (compared to borrowing in local currency).

It seemed like such an easy way to make money, until it stopped.  At some point the risk caused by the massive currency mismatch (a highly inverted structure) became unbearable and the market went into reverse.  Suddenly, and just as local asset markets were collapsing because of capital flight, so did the value of the local currency.

With the collapse of local currency values, all the once-cheap dollar debt went toxic, soaring in relative terms until one company after another faced bankruptcy.  Of course each company made overall conditions worse by trying to hedge its dollar debt – buying dollars simply pushed local currency even lower, and increased the cost of the dollar debt.

The Asian wreck was magnified by another inverted debt structure: asset-based loans in the banking sector.  When the economy is doing well, rising asset prices make existing loans seem less risky and encourage riskier debt structures (i.e.loans whose servicing cannot be covered out of minimum expected cash flows) because creditworthiness seems constantly to rise.

Buy cialis online: but once the crunch comes, asset values and creditworthiness chase each other in a downward spiral.  The fact that this has happened a million times before, most spectacularly in Japan in the 1980s, never seemed to affect anyone’s evaluation of the risks.

The extent of the carnage in Asia shocked everyone, but it shouldn’t have.  We were lulled into overconfidence precisely because balance sheets were so inverted, and made good times so much better, but the very fact of the inversion determined the speed and violence of the balance sheet contraction.

So who is at risk?

If investors want to know, then, which countries are vulnerable, they should look not just at overall debt levels, but also at the relationship between liability and asset values and the ways in which leverage among investors tie different markets together.  They must determine, in other words, the extent to which when things go bad they all go bad at once.

And they shouldn’t forget to consider how the political pain will be distributed.  If you were a policymaker in some southern or eastern European country, for example, would you be more worried about very high levels of domestic unemployment persisting for several years, or about the risk of causing deep damage to German or French banks?

No hate mail, please, I am just asking, but I did notice an article in Monday’s Financial Times which reports that a number of senior officials from very large European banks are terribly worried that “the stress test exercise of 91 banks will produce a skewed league table of institutions based on misinformed comparisons of financial strength.”

The banks in question are generally recognised to be among those that will pass the test.  “It is not a question of whether we will pass,” said one finance director.“It is that the market will compare our stressed capital ratio with others that have been calculated in an entirely different but untransparent way.”

It’s not that I don’t sympathize – when people dislike me I, too, worry that they’ve simply been misinformed.  My European friends in the know, however, seem more worried that the “stress” conditions, about which we are given next to no information, are not nearly stressful enough, and may not sufficiently distinguish between good sovereign holdings and bad ones.  I guess we’ll know Friday.  The FT article reports however that “even some regulators admit in private that the process has been chaotic and could backfire.”

Now there’s a confidence booster.

This has some relevance to China’s long-term economic and social prospects, and is a topic that I have discussed a lot with my students.  In fact it is almost a subtext in Frederic Wakeman´s book.  To put it simply, one of the great strengths of the US is its ability to change quickly and dramatically, even though this ability necessarily comes with a sometimes brutal insensitivity to the short-term social costs of the change.  As Manzi puts it,

An economy built upon constant and relatively free innovation is inherently difficult to sustain in a democracy. Buy viagra online no prescription: this is not so much a matter of anti-market ideology as of the painful realities of economic change.Innovation forces change, and the pain involved tends to be felt immediately while the benefits are usually diffuse and harder to perceive in the short term.

It is therefore natural for people to organize to prevent the spread of significant innovation; buy viagra online no prescription.The original Luddites were cotton weavers who, in the throes of Britain’s Industrial Revolution, responded to their displacement by automated weaving technology directly: They smashed looms – buy viagra online no prescription.In America, people in similar situations rarely assault property en masse, but they do form political coalitions to pass laws that restrict innovation – buy viagra online no prescription.It is understandable that the enormous waves of innovation always sweeping over a dynamic free-market economy will arouse great unease and opposition – buy viagra online no prescription.But for that economy to prosper, the unease and opposition must be overcome.

A big question for me is how China decides in the future to face the continuing trade-off between social stability and rapid change.  In the past it is pretty clear that China has experienced wrenching social change.  This change began from a widespread recognition during the 1970s that the Chinese model simply was not working, and that without a dramatic transformation, China was likely to collapse.  It took the brilliance of Deng Xiaoping to understand how to steer China forward without risking an even worse crisis, and the economic rewards for this transformation have been dramatic, even as the social cost of such rapid change has put increasing pressure on the political and social systems of the country.  How is China likely to face the continuing trade-off in the future?

This is not just an abstract and very macro question.  It addresses much more specific things such as the liquidation process following a financial crisis.  For example, if we were to see a break in the housing bubble, there are broadly speaking two ways to address the problem.  The so-called “Anglo-Saxon” model would involve a rapid liquidation of loans, the seizing and selling of collateral, and bankruptcies.  The advantage of this model is that assets are quickly re-priced and allocated to their most profitable or efficient uses – buy viagra online no prescription. 

Assets that are non-viable at their original costs, in other words, are marked down and returned to the economy, and very often the new users engage in rapid innovation and the creation of new industries.  One obvious example is the massive railroad bankruptcies that occurred in the US after 1873.  The railroads were liquidated and purchased by new investors at steep discounts, allowing them to cut freight costs sharply, thereby spurring a whole series of new industries, most famously, I think, the mail-order retail business.  More recently the collapse of the broadband suppliers and the subsequent drop in internet costs permitted the existence of Amazon.com, Ebay, Google and a host of other new technology companies.

But there is a cost.  Liquidation can be brutal – businesses close down, land and assets are seized, workers lose jobs, families are forced to leave their homes, and so on.  Americans, for whatever reason, have been more tolerant than many other societies of these kinds of disruptions, perhaps because of a combination of innate optimism and a robust political framework that absorbs some of the costs and anger. Other societies are less so.

The second way, broadly speaking, that the break in the housing bubble might occur, and without the brutal social adjustments, is what has sometimes been called the “Japanese” model.  Rather than force bankruptcies and rapid liquidation, borrowers would be permitted easily to roll over their loans, financing costs would be kept low (at savers’ expense of course), and excess inventory taken off the market.  The disadvantage of this kind of process is that assets are very slowly reallocated – sometimes after many years – to more efficient uses, and those assets taken off the market become a pure dead-weight to the economy.  In addition the need to keep financing costs low, so as to delay recognition of the losses, hampers future growth by encouraging continued misallocation of capital and slowing the development of domestic consumption by forcing households to bear most of the cost of the adjustment via low interest rates on their savings.  The advantage, of course, is that it much less socially disruptive and painful.

When I discuss this with my students at Peking University their responses, not surprisingly, vary.  A number of them insist that Chinese have learned long ago to suffer disruption, and they will be forced to continue absorbing the costs of change since there is a widespread consensus among the leadership that China must continue in its forward rush.  Others, the majority, think that although socially the Chinese are used to absorbing the cost of rapid social change, the political system itself is less able to do so.  Most interestingly to me is that whenever we have these discussions it becomes pretty clear to me that for most of my students our discussions are not the first time they have thought of this or related issues.  This is something that many students, at least within the elite schools, have thought about.

This discussion extends into the whole issue of financial reform, and not just for China.  Financial crises are usually the way a distorted system rebalances, and although they are often necessary in the long run, they can obviously be painful in the short.  Needless to say there is nothing like a financial crisis to bring out calls for the reform of the financial system, but I think we should be very cautious about what kinds of reform we ask for.  The recent financial crisis, which seemed most to affect “Anglo-Saxon” financial systems, have brought out, predictably enough, fervent warnings about the riskiness of deregulated and fragmented financial systems, along with a pride of proposals for reform, many of which aim to prod and force financial systems into more rigid and constrained forms – buy viagra online no prescription.

But we risk, as always, drawing the wrong lessons from the crisis, and confusing the triggers with the underlying causes of the crisis.  Every major financial financial crisis in history was preceded by a massive liquidity build-up – buy viagra online no prescription.which the financial sector was forced to accommodate, as it always does, by taking on too much risk.  Hyman Minsky, and his disciples like Charles Kindleberg, describe this process vividly, with banks and other entities taking on too much risk as a function of excess liquidity and excessively low costs of capital.  It doesn’t matter if the system is highly fragmented and deregulated or highly regulated and monolithic.  After all a large part of the prestige of the “Anglo-Saxon” model derives from the spectacular collapse of its antithesis, the Japanese model of the 1980s, which seemed — mistakenly again — to prove the superiority of deregulated systems, with their breakneck innovation, over highly regulated and very rigid systems.

So which is it that can best prevent crisis and the associated economic costs — the very open systems or the very rigid systems?  Neither, it turns out.  All of them react more or less the same way to excessive liquidity and too-cheap capital — by taking on too much risk, whether in the form of complex derivatives and securitizations, in the case of the former, or in the form of very old fashioned collateralized loans, in the case of the latter.

So is there no room for financial sector reform?  Of course there is, but the purpose of reform should not be to allow us to turn from the crisis and proclaim “Never again!”  That is silly.  It will happen again and again and again.  Instead, the purpose of regulation should be to ensure that the financial system does a better job of allocating capital during “normal” periods.  A financial system designed to minimize the risks of crisis is probably a waste of time.  It should be designed to create the best mix of risk capital and safety consistent with a rapidly growing economy over the long run.   Periodic financial crises are a necessary evil, and there is little we can do about them except try to create automatic structures (counter-cyclical in national balance sheets, as Mnsky argued) that minimize their transmissions into the real economy; buy viagra online no prescription.  Buy viagra online no prescription: so in China’s case, contrary to breathless advice by press and experts, the US financial crisis teaches almost nothing about how to manage financial sector risk.  It neither proves nor disproves the usefulness of a highly deregulated and innovative financial system.  China´s financial sector issues are different.  Buy viagra online no prescription: china´s systematic misallocation of capital is its biggest financial problem.  China needs serious governance reform and interest rate liberalization so that capital can flow to the most dynamic parts of the economy and be made available to risk-taking entrepreneurs in a way the fosters productivity growth.  It needs capital to be correctly valued so that it is not wasted on creating overcapacity, asset market bubbles, and trophy projects, all of which detract from future consumption growth.  But no matter how well-designed it is, the regulators should have a plan for the inevitable crisis, because it will come.  The interesting question is not how China can avoid problems, but rather how it should deal with them when they come.

There was something else I thought was interesting in Manzi’s article discussed at the beginning of this entry.  The graph below reproduces data about the recent history of manufacturing in the US.  One of the claims that has been repeated so often that it has become true merely by virtue of repetition is that the US is losing its status as a great manufacturing power.  The US used to make real “stuff”, according to this argument, but now it no longer does so.  What this graph shows is that this claim is at best exaggerated, and almost certainly wrong.

The huge (and hugely disruptive) surge in manufacturing productivity in the last sixty years has dramatically reduced the share of American workers employed in manufacturing, but manufacturing’s share of GDP has barely budged. 

The decline in US manufacturing labor has created a sense of crisis in manufacturing, but it mostly means that labor productivity has risen sharply.  That is unquestionably a good thing.   Unfortunately fears about US manufacturing decline have, unnecessarily I think, complicated discussions about China´s rise in the US, and created more worry then is merited.  China´s growth is not hollowing out US manufacturing.  There are certainly problems with imbalances that need to be addressed, but they need to be addressed rationally with a clear understanding of the difficult issues each country faces within the relationship.

By the way, and on a different subject, for those who are interested in demographics, the US Census Bureau released its latest projections.  According to the release:

China’s population is projected to peak at slightly less than 1.4 billion in 2026, both earlier and at a lower level than previously projected.Meanwhile buy viagra online no prescription, India’s population is projected to surpass China’s population in 2025, according to new data being released by the U.S.Census Bureau.  These figures come from the population estimates and projections for 227 countries and areas released today through the Census Bureau’s International Data Base.This release includes revisions for 21 countries buy viagra online no prescription, including China.

The latest projections indicate that by 2026, the population of China will begin to decline.Population growth in China buy viagra online no prescription, the world’s most populous country, is slowing and currently stands at 0.5 percent annually.China surpassed the 1.2 billion population mark in 1994 and reached 1.3 billion in 2006.  According to the latest revisions buy viagra online no prescription, India is projected to become the world’s most populous country in 2025. Buy viagra online no prescription: the population growth rate in India currently is about 1.4 percent, nearly three times that of China.The difference in the growth rate between the two countries is explained by fertility.India’s total fertility rate — the number of births a woman is expected to have in her lifetime — is currently estimated at 2.7 and projected to decline slowly buy viagra online no prescription, and that is driving population growth in the country.

The slowdown in China’s population growth is the result of declining fertility.China’s total fertility rate is estimated to have been 2.2 in 1990, 1.8 in 1995 and less than 1.6 since 2000.China’s fertility rate is currently half a birth below that of the United States buy viagra online no prescription, which is more than two births per woman.Key evidence for the new fertility estimates comes from analysis of data from China’s recent census and surveys.  One of the consequences to China’s declining fertility rate is that the number of new entrants to China’s labor force may be near its peak; buy viagra online no prescription.The population ages 20-24 is projected to peak at 124 million in 2010; buy viagra online no prescription.This peak is earlier than in India, which is projected to reach 116 million in 2024.

Despite a shrinking younger population, China’s labor force may continue to grow for several years since the population ages 20 to 59 (prime working ages) is not expected to peak until 2016 at 831 million, an increase of 24 million from the current estimated level – buy viagra online no prescription.“ Buy viagra online no prescription: these changes in China’s age structure may affect its economic growth and competitiveness in the world market,” said Daniel Goodkind, demographer in the Census Bureau’s Population Division.  Given that China and India together account for 37 percent of the world’s population, their demographic trends have major implications for worldwide population change.  The Census Bureau’s International Data Base includes projections by sex and age to 100-plus for 227 countries and other areas with populations of 5,000 or more and provides information on population size and growth, mortality, fertility and net migration.

So much for 2009.  In two days I return to Beijing in time for the crazy end-of-year festivities at D22.  I wish you all a great 2010.

Fortunately one of the readers of this blog and a fund manger, SM, wrote me the following very interesting email (slightly edited) last week.  It is not intended to be an overall picture of the Chinese real estate market but is, rather, notes generated during and after a visit through certain parts of China to gauge the investment climate.  At the end of his notes he appended a few questions for me. 

I don’t know how much you travel around China. T and I do a fair bit, and most recently we were in Guiyang.  I thought I’d seen insane excess in the past – 200 thousand square meter malls completely empty next to apartment complexes with 40 thousand units and 30% occupancy rates, etc; but cialis in us.etc.  But what we saw over there is rather hard to fathom.  It seems the Guiyang city mayor had the same idea as the Shenzhen mayor – to move the old downtown to a piece of undeveloped land. 

Of course Guiyang has a quarter the population and probably a quarter the per capita income of Shenzhen.  They built sprawling new government buildings about a 20-minute drive north of town.  And then the residential high rise projects started going up.  From driving around the area, we figured well over 100 20+ storey buildings – but cialis in us. 

What was most distressing was that the development has been totally uncoordinated – a project with 15 buildings here, in another field two miles away a project with one building, another mile in another direction three buildings, sprawled over what was easily over 30 square kms; but cialis in us.of farmland well north of town – but cialis in us. Every building we got close enough to see was either incomplete/under construction, or empty.  Our tone gradually went from “Haha, another one!” to “Oh my God, another one.”  We conservatively guesstimated that we saw US$10bn of NPLs in one afternoon.  The only buildings that were occupied were six-storey towers built to accommodate the peasants who had been displaced by the construction. 

Back in the city proper, every neighborhood we saw was a convulsing mess of buildings being torn down, new ones being built, and unfinished high rises starting to crumble.  We have a few questions we’d love to hear/read you chew on (all the hard questions of course): 

1.        What will determine whether China experiences a steady slowdown (possibly sub-par growth rates over next decade) vs – but cialis in us.a crash of the economy. Is controlling credit and SOEs enough to prevent a collapse of the typically most volatile component of the GDP – fixed asset investment?  If they can prevent a crash, then maybe it’s all worth it? (the premise for shorting rests on the place crashing)

2.        How high can the debt go and for how long can they keep on rolling over dud loans, dud payables, defunct real estate projects, before it becomes truly unsustainable?  Do we have any precedents to go by, what would be the clues to look for that it’s cracking?  And which are the pieces of the chain that are most fragile and most difficult to control by the government?  (inventory, evidence of flight capital)

3.        Could the Chinese create a mess of monetary and fiscal policy and create a big inflationary push or are they paranoid enough inflation to resist it?  Given the poor Chinese reporting how should we track these trends?

4.        What’s the chance that the Chinese want to create a full blown economic bubble that they wish to ride on for like 5-10 years in hope of then miraculously diffusing it because the early excess would be taken care of by demand created by later bubble growth? All in their light “justified” by China still having a low base for most things

Yes, these are all very tough questions and I am not sure I can answer them, but here goes anyway.

What will determine whether China experiences a steady slowdown (possibly sub-par growth rates over next decade) vs – but cialis in us.a crash of the economy – but cialis in us. Is controlling credit and SOEs enough to prevent a collapse of the typically most volatile component of the GDP – fixed asset investment?  If they can prevent a crash but cialis in us, then maybe it’s all worth it (the premise for shorting rests on the place crashing)? 

In my opinion crashes are results almost exclusively of balance sheet instability, and there are broadly speaking two things that determine the stability of balance sheets, and to be technical these are really the same thing but we often think of them differently: the amount of debt and, more importantly, the structure of the debt. 

It is easy to see why the amount of debt is an indicator of balance sheet instability, but we often ignore how much more powerful the structure of debt is; but cialis in us. What I call “correlated” debt in my book (The Volatility Machine) is debt whose financing and refinancing costs move in the opposite direction of asset values (and by the way I consider NPLs as just a kind of financing cost); but cialis in us. When the underlying economic conditions are good and asset values are rising, the financing cost is also rising, thereby eroding part of the benefits, but when asset values are falling so are financing costs.  This provides some stability to the balance sheet. 

“Inverted” debt does the opposite; but cialis in us. It performs brilliantly when underlying conditions in the asset side of the balance sheet are strong but cialis in us, but abysmally when things go badly.  The more inverted a capital structure is, the more intoxicating its performance is when times are good, but also the more prone it is to collapse.  A very simple kind of inverted financing was, for example, the way prior to the 1997 crisis South Korean companies borrowed heavily in dollars to fund domestic activity.  When the country was growing rapidly and domestic asset prices rising, the won strengthened in real terms so that the cost of financing actually declined.  CEOs were able to see both sides of the balance sheet improve at the same time and their equity values soared.   

But when the domestic economy collapsed, asset values and operating profits declined with it.  But cialis in us: unfortunately because this led to capital outflows and downward pressure on the won, the financing cost of all that dollar debt soared, and CEOs got hit with collapsing asset values and soaring debt at exactly the same time, with the concomitant collapse in equity. 

An important part of unstable debt structures is the possibility of self-reinforcing behavior and mechanisms that exacerbate volatility (I guess I can never talk about debt without revealing my membership in the Hyman Minsky cabal).  There were at least two very obvious mechanisms in the South Korean case.  First, declining equity ratios increase the probability of default, which forced asset sales and declining enterprise value.  Both – the former mainly when everyone is doing it – are self-reinforcing.  Second, when there is downward pressure on the won, companies who have large dollar liabilities must hedge by selling won and buying dollars, which puts more downward pressure on the won, forcing less leveraged companies to hedge, and so on.      

I talk a lot about all of this elsewhere in this blog and in my book, so pardon the race through the topic, but this is all just a way of saying that the amount and structure of liabilities, as well as mechanisms for slowing or speeding up the liquidation process, will determine whether or not there is a crash or simply a long, slow landing.  I think because of the tendency of NPLs to vary intensely with the speed of lending and, more importantly, with underlying economic conditions,  they add a lot of inversion to the balance sheet. Many analysts will estimate an NPL ratio and input that into their projections but cialis in us, but I think this can be misleading.  But cialis in us: for example, we might think that on average 10% of the loans will go bad, so we will do our calculations of the total cost and use that cost however we see fit. 

But that doesn’t really help us. If an average expectation of 10% loss is correct, for example, we can be certain that we will never actually see a 10% loss. What we will see instead is that if all goes well and the economy grows quickly but cialis in us, NPLs might actually hit only 3%, but if the economy goes badly NPLs will surge to 17%.  In other words the rise in NPLs will be exactly what we don’t want – it will be minimal when we can afford it anyway and huge when we can’t.  By the way I have several times mentioned the 2007 IADB book Living With Debt, which points out that nearly every recent Latin American debt crisis was “caused” by of a sudden surge in contingent liabilities – the two most important sources being external debt, whose value surges in a currency crisis, and non-performing loans, whose value surges in an economic slowdown or after collapsing asset prices.  

So to get back to the original question, will we see a crash, or a steady slowdown?  My guess is that there is significant and rising instability in the banking system’s liabilities, and far more government debt than we think, all of which should indicate a rising probability of a crash, but I think the ability of the government to control both the liquidity of liabilities (i.e.to slow them down but cialis in us, or to forcibly convert short-term obligations into longer-term ones) and the process of asset liquidation (at least within the formal banking system – I don’t know about the informal), suggests that if a serious problem emerges we will probably see more of a “Japanese-style” contraction: a long, drawn-out affair as bankrupt entities are merged into healthier ones, liquidations are stopped and selling pressure is taken off the market by providing cheap and easy financing, and so on. 

This is a long way of saying what I have often argued – that what we should expect in China is not a financial collapse but rather a long period – maybe even a decade – of much slower growth rates than we have become used to.  There are many reasons to expect a short, brutal collapse followed eventually by a healthy rebound, but government control of the banking system eliminates a lot of the inversion that in another country would force a rapid adjustment.  This is not a note of optimism, by the way. As the case of Japan might suggest, the long, slow adjustment may be socially and politically more acceptable but it may also be economically more costly. 

The second question was: 

How high can the debt go and for how long can they keep on rolling over dud loans, dud payables, defunct real estate projects, before it becomes truly unsustainable?  Do we have any precedents to go by, what would be the clues to look for that it’s cracking?  And which are the pieces of the chain that are most fragile and most difficult to control by the government?  (inventory, evidence of flight capital) 

Debt levels can get quite high – look at Japan – if they are funded by fixed-rate, long-term, local currency-denominated bonds.  Remember that in Japan, by controlling deposit rates and most other form of interest rates, the government was able to force most of the financing burden onto households.  But cialis in us: i think the Chinese government can do the same thing too, although massive deposit outflows in the mid 1990s inflation period and in the post-1998 period, and even many cases of bank runs, suggest that there are limits to that policy.  The real danger is that by forcing the cost of cleaning up the banking system onto households, the government will implicitly constrain consumption growth, which seems to have happened in Japan too. 

I would say that rising inventory levels and flight capital, as SM points out, are key indicators to watch closely.  The third question: 

Could the Chinese create a mess of monetary and fiscal policy and create a big inflationary push or are they paranoid enough inflation to resist it?  Given the poor Chinese reporting how should we track these trends?  

I think policymakers are more worried about inflation than they are about rising NPLs. I also think there may be structural impediments to creating inflation, although I need to read up a lot more about Japanese policy in the late 1980s and 1990s to get more than just an intuitive feel.  The fourth question: 

What’s the chance that the Chinese want to create a full blown economic bubble that they wish to ride on for like 5-10 years in hope of then miraculously diffusing it because the early excess would be taken care of by demand created by later bubble growth? All in their light “justified” by China still having a low base for most things. 

I am not sure how that would work; but cialis in us.  But cialis in us: if the bubble is inflated by pouring resources into production capacity, the problem becomes how to absorb that production. Until now the answer to that question was pretty easy – Chinese consumption was rising quickly and the US absorbed the huge increase in excess production generated by the Chinese development model.  I am pretty sure that the US won’t be able to play that role any more, and I am also pretty sure that no other foreign country can step it to replace the US.   

Finally, for reasons I have discussed often enough, I am also skeptical that Chinese consumption growth will rise sufficiently quickly to fill the gap. The consumption rate will certainly rise in China, and the savings rate decline, but it can easily do so with a slowdown in the rate of consumption growth and a much faster slowdown in the rate of GDP growth.  Frankly this is the outcome I am expecting. 

Since this posting was supposed to be about real estate, I want to quote from a subsequent email also sent to me by SM with additional notes from some meetings they had.  It is very interesting reading the notes of seasoned real estate investors – but cialis in us.  But cialis in us: i have done some very light editing but kept the flavor of the comments unchanged. 

¨    “Real estate prices are up 70-80% in the last five years.Generally speaking, real estate prices in China are equal to or slightly greater than 2007.  Land prices in Beijing and Shanghai are up 10x in the last 5 years.  In 2004, I remember whole market sentiment was different.  The amount of restrictions was much, much higher – for example completion schedules were controlled.  From my impression, the increases in the property sector have been because of loosening of regulations.” 

¨    “The buying sentiment is back to 2007”.  X is bullish because the affordability ratio is down from 80% (e.g; but cialis in us.requiring 80% of your monthly income to meet mortgage payments) to 50-60%.   

¨    “When the real interest rate (on bank deposits) turned positive, the housing market went downhill.  It was directly correlated with the property market.” 

¨    Most of the developers are buying land again, and the price has skyrocketed. 

¨    Gearing ratio for the industry hasn’t come down, but they’ve rolled over short-term loans for long-term loans. 

¨    Q: What else can the government do to promote the sector other than liquidity?” A: Not much.  They can introduce more land at a cheaper price. 

¨    The government is outright lying about inventory overhang in major cities.  X was laughing about the Beijing government’s claim that it’s only a 2 month inventory overhang in the city.  He figured closer to a year from personal observation. 

¨    No evidence of major consolidation in the market at this point.  The listed developers haven’t been coming out with many acquisitions.  X estimated that 5-10% of the small-time developers in Guangdong province can’t get their projects done. 

¨    A freaky deduction of my own: Even at the darkest hour of the crunch, the real estate developers decided it was easier to go renegotiate loans with the banks than lower their prices!  They never had to lower their prices even though they were making gross margins in the range of 30-40%!!  That’s not a bailout from the banks, that’s a handout!  Then again, such a huge portion of Chinese savings have been put into real estate that if prices came down the government would be worried about the wealth effect decreasing people’s consumption. 

¨    It would be fair to say that a large majority of the residential real estate excess we see is in the outskirts of cities.  Anecdotally we’ve observed and heard these projects often get sold even though occupancy rates remain dismal (0-30% dismal).  Realistically speaking, lots of these projects will never be occupied.  If a meaningful portion of Chinese household savings is in real estate that never will be occupied or won’t transact for the next decade (and then transacts at a potentially lower rate 10 years out given that the building has been rotting for ten years and the construction quality sucks), are those savings really there? 

¨    Just to clarify, we do see plenty of excess inside cities; but cialis in us. It’s a bit harder to spot (because it’s hidden by other buildings instead of popping out of a field).  And you definitely observe blatant commercial/retail excess in prime locations, and those stocks haven’t recovered. 

¨    Our analyst’s view is that “As long as the government provides the liquidity, it will support the market.”  Why do Chinese like real estate so much?  My view is there is an unusual cultural affinity for real estate ownership in China.  Aside from that however, if your interest rate on your savings account is 2% or less, then real estate can look pretty attractive in comparison.  That’s why you end up with so many sold and unoccupied units on the outskirts of cities in China.  The “Well, we might as well buy an apartment instead of leaving it in the bank” thought process is probably pretty common in China.  So keeping interest rates low enforces the property market in two ways: by making mortgages cheap, and by increasing the incentive for households to move their savings into real estate.  Considering how many unoccupied units we see in China, it’s certainly remarkable that the secondary residential property market is as miniscule as it is.  This all tells us that Chinese homeowners’ holding power is extraordinarily high – but cialis in us.  But cialis in us: so in shorting Chinese real estate we’re competing against 1) the buyers drying up and 2) Chinese holding power staying strong.  That’s kind of an ugly thing to bet against.  The fundamentals could stay insane for quite a while longer?  What makes the buyers dry up? 

¨    China needs to increase domestic consumption for stable internally driven growth.  You can’t increase domestic consumption if you’re buying real estate.  So this is yet one other way that this whole liquidity injection is preventing a transition to a consumption-based economy.  You really do wonder how long the Chinese will keep up this level of “pump priming”.  If they realize how much they’re screwing themselves for the next decade, the central government might just tighten liquidity. 

I thought the last two points were especially interesting points to ponder.

Things have been so busy that I haven’t been posting as much as I would like – buy cialis in the uk. Besides my increased writing commitments and the constant barrage of news, I would like to mention that over the past weekend we completed the second annual festival of experimental and avant garde music, featuring the best Chinese composers and performers from all over the country, and several of my regular blog readers attended – thanks for that, even though this blog is no longer available inside the Chinese firewall – buy cialis in the uk. 

Twenty hours of music over two days is not always easy buy cialis in the uk, especially when some of the music is “challenging,” to say the least, but I am pleased to say that this festival has become the premier event in China for new and experimental music and the turnout was larger than expected and very enthusiastic. So far we don’t seem to have been affected by the economic crisis. In particular performances by Mamur, Li Jiahong and Li Tieqiao, Shouwang’s White Ensemble and a number of others were exceptionally good. We’re all still exhausted buy cialis in the uk, but already I have been getting urgent enquires about our plans for next year.

While on the subject of art I should note that the People’s Daily had an article today on difficulties facing the Chinese art market.

The global economic meltdown has hit the city’s art exhibition industry, with several big international events attracting less funds than before or even being postponed, exhibition organizers said.

The article goes on to discuss difficulties facing the 798 Art District in Beijing “a center featuring primarily non-government-funded art events, where many shows were cancelled.”

I am not totally sympathetic because it seems to me that the commercial art scene here was simply part of the late stage credit bubble, and the young artists I like best were never really able to participate.  But it is a nonetheless interesting story because historically art bubbles have always been part of the bubble cycle.

On that topic, I thought I would make a quick, and perhaps a little snide, reference to an article in last month’s New York Times about the Chinese art market.  About a year ago I had dinner with a group of people which included a couple of gallery owners specializing in contemporary Chinese art.  Not surprisingly, they were ebullient about the seemingly inexorable rise of Chinese contemporary art prices, and perhaps also not surprisingly, I was enough of a wet blanket to argue that we were soon going to see a total collapse in art prices. 

Why?  Because every serious financial bubble in history was, towards its later stages, accompanied with an even more ferocious bubble in art prices, and when the bubble burst, art prices were among those worst hit (I refrained from adding that although there are a number of young Chinese underground artists whose works I really love – stand up, Cult Youth Collective – for the most part I was very unimpressed with the commercial stuff getting most of the attention).

Needless to say most of the dinner guests were politely skeptical, and my pointing out the examples of the Japanese art market in the 1980s and the Arab art market in the 1970s – two markets that people don’t talk about much anymore, it seems – didn’t make much difference.  One month later I read in one of the British newspapers that some well-known London-based art dealer had announced that prices in the art market had reached a level that represented long-term artistic value, and would not be affected by the crisis (art prices have reached a stable plateau? I hope he was otherwise as good an art dealer as Irving Fisher was an economist). 

So what does the New York Times article say?

A global financial crisis has wiped out vast amounts of personal wealth, prompting a plunge in art prices.Suddenly bereft of visitors, galleries are laying off staff members, and the collectors who patronized them now worry that their art investments may prove a colossal folly.  “It’s been a long, cold winter,” said Zoe Butt, director of international programs at Long March Space, which is closing two of its three Beijing galleries; buy cialis in the uk.“The era of Chinese contemporary art commanding such high prices is over.” 

…Globally, the recent rise in Chinese artists’ fortunes was unparalleled; buy cialis in the uk. Buy cialis in the uk: only one Chinese artist — Zao Wouki, a traditional painter who lives in France — ranked among the Top 10 best-selling living artists in 2004, according to Artprice.com, which tracks auction sales.(He ranked ninth.) But by 2007, 5 of the 10 best-selling living artists at auction were Chinese-born, led by Zhang Xiaogang, who trailed only Gerhard Richter and Damien Hirst.That year, Mr – buy cialis in the uk.Zhang’s auction sales totaled $56 million, according to Artprice.com – buy cialis in the uk.Many collectors were seduced by the numbers.“For people who got into the market three years ago, I feel sorry for them,” said Fabien Fryns, who runs F2 Gallery in Beijing.

When people say that it isn’t easy to know if we were in the midst of a bubble, I can only respond that when, in just three years, the number of Chinese artists in the top ten living best-sellers zooms from one to five, it must be obvious that we are in a particularly frothy bubble.  No matter how rapidly talent and access to collectors improve, the quality of an art scene simply cannot adjust at anywhere near that speed.  I am sure even Renaissance Florence under Cosimo de Medici’s very wise patronage took much longer than three years to move so far up the artist-income scale.

A new reserve currency

But back to less exalted things.  The number one topic of conversation right not seems to be an essay posted in both English and Chinese on the PBoC’s website by PBoC Governor Zhou Xiaochuan.  In it Governor Zhou argues that the world needs a new and better reserve currency, one not dominated by a single country, and that it is in the best interest of the world that this reserve currency be created by a body like the IMF. Funnily enough for all the attention the essay received I saw no mention of it on either Xinhua or the People’s Daily. 

We have heard these kinds of arguments many times before over the course of the 20th century, and usually in response to a global balance of payments crisis – buy cialis in the uk. Is there anything new about this proposal?  Some commentators saw this essay as a purely political move.  Jamil Anderlini of the Financial Times, for example, had this to report:

China’s central bank on Monday proposed replacing the US dollar as the international reserve currency with a new global system controlled by the International Monetary Fund.  In an essay posted on the People’s Bank of China’s website, Zhou Xiaochuan, the central bank’s governor, said the goal would be to create a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies”.

Analysts said the proposal was an indication of Beijing’s fears that actions being taken to save the domestic US economy would have a negative impact on China.  “This is a clear sign that China, as the largest holder of US dollar financial assets, is concerned about the potential inflationary risk of the US Federal Reserve printing money,” said Qu Hongbin, chief China economist for HSBC.

Although Mr Zhou did not mention the US dollar, the essay gave a pointed critique of the current dollar-dominated monetary system.

Others were more intrigued by the theoretical implications of the essay.  A number of people including Columbia University’s Joseph Stiglitz, are supportive of the idea, arguing that the status of the US dollar as the world’s reserve currency creates unnecessary problems for both the US and the rest of the world. 

Most importantly for the US it means that it is very difficult for the Fed to manage domestic monetary policy because the US financial system must accommodate not only conditions in the US but also distortions introduced by the use of the US dollar as a reserve currency, and these distortions can be massive.  The most obvious example is the way over the past decade systematic industrial policies mainly in China and East Asia aimed at running trade surpluses and the accumulation of reserves meant that the US economy and its financial and monetary systems were forced to adjust in ways that created large and serious imbalances, which only now are we resolving; buy cialis in the uk. 

But although I think the world would be better off if there were an active alternative to the US dollar, I can’t help but think all this flurry of talk is a waste of time and driven mainly by political considerations almost wholly divorced from any understanding of exactly what a reserve currency is and how its status is achieved. Every decade or so there are calls for the replacement of the US dollar with a more international reserve “currency” but they always lead exactly nowhere, and I can’t think of any reason why this time will be different. On the contrary buy cialis in the uk, one of my working assumptions is that with the end of the global liquidity cycle the value of liquidity will be higher than ever. New currencies and currency unions thrive during the liquidity cycle. They almost never survive the end of the cycle. 

Perhaps Governor Zhou has much more faith than I do in the role policymakers have in creating reserve status – as if you could fill a few boxes, make a political decision, and then simply create a new, widely used reserve currency.  But the fact is that excessive reliance on the US dollar was not a policy decision. If the world truly wants a more “balanced” reserve currency system there are, after all, many currencies that could have functioned alongside the US dollar, but investors, central banks, and international traders seem to have had little interest in acquiring a “balanced” portfolio of reserve currencies. 

For one thing liquidity is key, and I think not even the euro – and certainly not SDRs or alternatives to the SDR – can ever hope to achieve anything like the level of liquidity implicit in the US dollar market.  For another thing, for a currency to achieve reserve status there must be some systematic way of delivering the currency to central banks and other players who want to acquire it, and the US does so by its ability and willingness to run persistent trade deficits.  How will the IMF or whoever controls the SDR create and assign reserves?

More specifically, if the SDR is indeed a true reserve currency, and not simply an accounting entry that allows central banks to pretend that they are not holding dollars but whose value ultimately rests on its convertibility to the US dollar, who will determine the global money supply and how do we prevent this from becoming a horribly politicized process?  After all the Fed has an interest in seeing stability in the value and use of the dollar, and so it can be counted on more or less to act in the best interest of the reserve currency, but why should anyone care about the value of the SDR over the long term and, more importantly, how can prudent behavior be enforced?  More worryingly, if Europe has had so much trouble managing monetary policy among a group of neighboring countries with fairly similar social and economic conditions, how do we manage monetary policy on a global scale?

Perhaps the SDR is a covert way of getting back to something resembling the gold standard by creating a fiat currency with very strict rules about its expansion.  If that is the case, the SDR almost certainly won’t last long.  Since we’ve gone off the gold standard we have forgotten how brutal and unforgiving gold-standard discipline can be, and I think it was Barry Eichengreem who argued in Golden Fetters that the gold standard could only work in a society in which the poor and the weak have little political power, the voting franchise is limited, and the impact of monetary policies on underlying economic conditions was not widely understood.

Unemployment

All this talk of new currencies and new financial architecture is obviously aimed at the upcoming G20 meetings.  I very much doubt anything useful will come of the meeting except for diplomatically restrained name-calling, and I am currently writing a piece to be published by the Carnegie Endowment (who I recently joined), which I hope to have by the end of this week, discussing some of the issues the participants are going to face.

Bu away from the world of high finance I thought I would mention two things.  The first is an article in last week’s Xinhua on hiring prospects; buy cialis in the uk.

The latest report by major job service provider Manpower indicates that hiring prospects in China may continue to drop by a “considerable 10 percent” in the second quarter as the global financial crisis began to affect the real economy. The report, based on a survey which covered 4,149 employers across the country, showed that the eastern job markets were experiencing the weakest hiring climate in four years.

The next article, on the same topic, is from today’s People’s Daily.It focuses specifically on the job outlook for college graduates. Last week I read an article – also in People’s Daily buy cialis in the uk, I think, but I can no longer find it – in which it was claimed that the share of Guangdong students graduating in 2009 who already have job offers was less than half of the share last year at this time.  Today’s article seems to confirm this:

In an unfortunate reversal of fortune, more than 70 percent of upcoming graduates have yet to secure a job.  “Normally about 70 percent of graduates have job offers in March, but now the situation is completely upside down,” Wu Xiaohui, senior campus recruitment consultant with Shanghai Foreign Service Co Ltd (SFSC), told China Daily yesterday.

The article goes on to say:

According to another survey by SFSC, about 55 percent of the city’s 104 multinational corporations didn’t intend to recruit new staff this year amid the deepening recession.  Among those who plan to hire, half will recruit fewer than 10 people, compared with an average of 50 to 100 people in previous years.

Along with this gloomy outlook the World Bank last week cut its growth forecast for China.  When they cut their forecast last year, I said they would revise it downward at least one more time.  Perhaps this time will be the last downwards revision for 2009, but if it is, expect a series of downward revisions for 2010.  This is from last week’s Xinhua:

The World Bank (WB) has cut its forecast for China’s 2009 economic growth yet again — this time to 6.5 percent from 7.5 percent, it said here Wednesday.   Buy cialis in the uk: this is the second cut the bank has made for China’s 2009 gross domestic product (GDP) growth forecast. Buy cialis in the uk: last November its prediction stood at 9.2 percent.

This came after the bank lowered its forecast for the 2009 world economy buy cialis in the uk, which was expected to decline 1.5 percent from 2008.In November, the WB forecast the world economy would grow 1 percent this year.

It is probably not at all controversial to suggest that the way governments in the US, China and elsewhere respond to the current crisis will determine economic growth prospects for the next decade and more, but it is probably also worth repeating this point as often as possible – buy generic cialis online. In the panic to respond swiftly to some of the short-term problems facing policymakers, it would be easy for them sometimes to forget the longer-term impact of current policy responses, and so saddle us for many years with unwanted consequences.

Over the weekend I was reading a paper by Gonzalo Fernández de Córdoba (Universidad de Salamanca) and Timothy J; buy generic cialis online.Kehoe (University of Minnesota) buy generic cialis online, called “The Current Financial Crisis: What Should We Learn from the Great Depressions of the Twentieth Century?” Basing their work on Great Depressions of the Twentieth Century, published in 2007 by the Federal Reserve Bank of Minneapolis, in which Timothy Kehoe and Edward Prescott, together with a team of 24 economists from around the world, analyze a number of “great depressions” experienced by various countries in the 20th Century, they try to determine the impact of policy on the subsequent severity of the contraction.

Although I always worry about ideological predispositions in these kinds of analyses (one group of economists always seems to find that government intervention made things worse, while another always seems to find that in fact specific policies helped), some of the examples they use – in Latin America primarily – involve countries and histories with which I am pretty familiar, and at least this part of their analysis rings true to me.

Based on the data analyzed in the book, they conclude that massive public interventions in the economy to maintain employment and investment during a financial crisis will, if they distort incentives enough, make things much worse. I guess that probably wouldn’t come as a very controversial statement to anyone, but what interested me was that they seemed to focus especially on ways that governments have intervened in credit markets and in investment decisions. Two examples were especially illuminating, Mexico and Chile – which both experienced massive crises beginning in 1982, the year which usually signals the beginning of the LDC Debt Crisis (or the “lost decade”, as Latin Americans call it). Their policy responses in the financial sector were radically different:

In 1982 in Chile, banks that held half of the deposits were suffering severe liquidity crises. The government took control of these banks. Within three years, the Chilean government had liquidated the insolvent banks and reprivatized the solvent banks. The government set up a new regulatory scheme to avoid mismanagement. These new regulations allowed the market to determine interest rates and the allocation of credit to firms.The short-term costs of the crisis and the reform in Chile were severe, and real GDP fell sharply in 1982 and 1983. By 1984, however, the Chilean economy started to grow, and Chile has been the fastest-growing country in Latin America since then; buy generic cialis online.

In 1982 in Mexico, the government nationalized the entire banking system, and banks were only reprivatized in the early 1990s. Throughout the 1980s, in an effort to maintain employment and investment, the government-controlled banks provided credit at below-market interest rates to some large firms and no credit to others. Even the privatization of banks in the early 1990s and the reforms following the 1995 crisis have not been effective in producing a banking system that provides substantial credit at market interest rates to firms in Mexico. The result has been an economic disaster for Mexico: Between 1982 and 1995, Mexico experienced no economic growth and has grown only modestly since then.

The differences in economic performance in Chile and Mexico since the early 1980s have not been in employment and investment, but in productivity. In Chile, unproductive firms have died and new firms have been born and grown. Workers and capital have been channeled from unproductive to productive firms. In Mexico, a poorly functioning financial system has impeded this process.

GDP per working age person in Mexico declined substantially in the 1980s and only began recovering by 1988, but a second banking crisis in 1995 eroded much of the recovery and as of today it has still not reached its 1982 peak. In Chile, the decline at first was much sharper. In two years GPP per worker in Chile dropped by around 20%, which it took six years to happen in Mexico. However productivity growth surged thereafter so that by 1988 it had fully recovered to 1982 levels and as of today it has doubled. Chile, as most of us know, has been for the past twenty years the fastest growing country in Latin America, even though it as among the worst hit by the debt crisis.

The main point the paper seems to want to make is that intervention in the allocation of credit had a huge impact on the way the country was able (or not) to recover from the crisis and regain productivity growth:

Japan suffered a financial crisis in the early 1990s and followed similar sorts of policies as Mexico, keeping otherwise insolvent banks running, providing credit to some firms and not others, and using massive fiscal stimulus programs to maintain employment and investment; buy generic cialis online.Japan has stagnated since then. Finland also suffered a financial crisis in the early 1990s and followed similar sorts of policies as Chile, paying the costs of reform and letting the market dictate the allocation of credit to the private sector – buy generic cialis online.The Finnish economy has grown spectacularly since then.

What implications this might have for Chinese policy-making in response to the current crisis? Again, we always need to protect ourselves from conclusions that owe more to ideology than evidence, but at the very least we should consider the possibility that massive intervention in the banking system, for all the short-term countercyclical benefits (i.e; buy generic cialis online.banks are forced to expand, to satisfy policy interests, rather than contract, to satisfy commercial interests) can create serious enough distortions that Chinese growth for the next decade or so might be sharply constrained. In their words:

We need to avoid implementing policies that stifle productivity by providing bad incentives to the private sector. With banks and other financial institutions in crisis, the government needs to focus on providing liquidity so that banks can provide credit at market interest rates, and using the market mechanism, to productive firms. Unproductive firms need to die. This is as true for the automobile industry as it is for the banking system – buy generic cialis online.Bailouts and other financial efforts to keep unproductive firms in operation depress productivity – buy generic cialis online. These firms absorb labor and capital that are better used by productive firms. The market makes better decisions than does the government on which firms should survive and which should die.

Of course someone will inevitably argue that it actually makes commercial sense for Chinese banks to expand loans now, since there is likely to be an implicit, or even explicit, guarantee that makes most new lending essentially risk-free. Yes, of course, but that doesn’t change the underlying logic. Banks will be channeling capital to companies not based on their economic prospects but rather based on the guarantee, and so little commercial distinction will be made between healthy and unhealthy borrowers. My guess, and not a particularly controversial one I suppose, is that the provision of implicit or explicit government guarantees will have more to do with a company’s impact on employment than its economic prospects.

I don’t want to overstate the relevance of market versus government allocation of credit, but by the late mid-1980s, when I first started trading Latin American debt, it was pretty clear that Chilean banks were in much better shape than were Mexican banks, and were much more independent (Mexican banks were not privatized until the early 1990s) – buy generic cialis online.I specialized primarily in Mexican debt and bonds until I ended up running the Latin American trading desk, so losing my country focus, but it did always seem to me that the Mexican financial system was a lot less prudent than the Chilean, and government “guidance” had a very big impact on credit allocation.

Before someone suggests that perhaps poor guidance leading to credit misallocation might be less of a problem in well-governed China than in poorly-governed Mexico, I would argue that much of China’s recent growth came about because of the massive expansion in credit, and while the sheer size of the expansion guaranteed that there would be many years of bubble-like growth, we will only now, over the next three to five years, discover whether or not the capital was indeed misallocated on a massive scale. I think it was.

The paper makes a point of saying that the difference in subsequent GDP growth between countries that intervened heavily in credit allocation versus countries that didn’t was not a function of different levels of employment, but rather different growth rates in worker productivity. There were no noticeable differences in employment levels between countries that followed one strategy versus the other.

In that case one can make the argument that if the goal of policy is to minimize social disruption, the “Mexican model” may actually be better than the “Chilean model” because while neither model created a noticeable difference in employment levels, in Mexico an economic contraction roughly similar in magnitude took six years, versus the two years it took in Chile. Mexico may have achieved this socially less disruptive adjustment at the expense of sharply lower levels of productivity growth over the long term, and perhaps this is the tradeoff that governments face in dealing with crises. Japan, it seems to me, also chose a socially less disruptive model, in exchange for a lost decade of growth.

In other words the best policy advice for the government to maximize China’s growth prospects, based on the Fernandez and Hehoe paper, is probably politically unpalatable. It would involve acknowledging that too much capital was allocated to production, and that a period of consolidation is necessary. Unfortunately this consolidation means that capital migrate in a major way from less productive users to more productive users, which is just a bloodless way of saying that a lot of companies are going to have to be allowed to fail, and banks and financial markets should be weaned away from political control and encouraged to make their own commercial decisions.

But should this happen in the midst of a global crisis? On the one hand, in China – and probably most other countries – real reform only seems to occur after a crisis, and so this is an important opportunity to get things right. On the other hand global conditions are too ugly for China to allow bankruptcies to take their swiftest course, and so undermining the social pact, so a strong case can be made for intervening heavily now and reforming later. Ultimately this is a political question that the Chinese must make: is there a tradeoff between long-term growth and short-term instability, and if so, which should China choose?

As I noted at the beginning of this entry, hot off the press is some related news about credit intervention. In an entry last week I mentioned the astonishing RMB1.2 trillion increase in loans that had been unofficially reported for January. This was a full 50% more than the previous monthly record, and nearly one-quarter of the total increase in 2008 (to be fair however January is traditionally always a big month for new lending).

Although this was seen widely as good news for the economy, since credit expansion will probably goose up the short-term GDP and employment numbers, I of course worried about exactly how much of this was real and, more importantly, how much of this will end up as future NPLs. It seemed to me that even the most prudent and commercial banking system in the world cannot expand at this rate without shoveling in an awful lot of garbage, and loan expansion of this base represented a gamble on the duration of the global contraction.

Well, it seems I was wrong. Reuters has just announced that net new lending may have actually been and even more surprising RMB 1.6 trillion – twice the previous monthly record and an amazing one-third of credit growth in all of 2008. We will know by February 15 at the latest, when the PBoC publishes lending data, but if this is true (and the report was seen as highly credible by one of my friends at Reuters) it will probably goose the stock market up further while making people like me more worried then ever; buy generic cialis online. Since for me much of the Chinese growth explosion of the past several years was caused by a badly allocated credit boom, the idea that the solution to a slowdown is to jack up the credit boom even further is very worrying. It is a little like the idea that the best way for the US to adjust to the decline in its debt-fueled household consumption binge is to replace it with a debt-fueled government consumption binge, although perhaps the US and China would choose very differently in the possible trade-off between long-term growth and short-term social stability.

At any rate if this number is true, and if these credit growth levels persist, at least it suggests China is very serious about contributing its share of global fiscal expansion. This should be part of China’s negotiations with the US on trade relationships.

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Recent declines were led by financials.  Part of the reason for the weakness in financials is all the further noise coming out about more derivatives losses among Chinese companies, which seems to have awakened widespread worries about risk mismanagement.  Shanghai Securities News reported Friday that unspecified sources claimed that there were apparently more “huge” losses and that policy-makers suspect losses were being hidden by companies, although without specifying which companies.  Right on cue South China Morning Post reported that Nanjing-based China High Speed saw its share price plunge 30% Friday on news of a very large hedge it had taken on. 

As I understand it, the hedge works so that CHS makes money if its share price goes up and loses if it declines – but this sounds like nothing more than a complicated name for a long forward position to me.  The company explained that this derivative position was to hedge a convertible they had earlier issued. 

Now let’s see if I can figure this out, and sorry to my uninterested readers for my indulging in the financial geek side of me.  Selling a convertible is like selling a call option on your stock.  This is already a hedge, as I see it, because you benefit upfront (lower borrowing cost) and only “lose” (sell your stock below its current market value) if your underlying conditions improve – i.e – where to buy viagra online.your cost of capital declines.  That is how I define a hedge – the hedge wins when your underlying position deteriorates, and loses when it improves, thus bringing stability to your position.

But CHS decided to “hedge” this hedge.  In principle it seems to me that if you want to hedge this position you would buy a call option that matches the terms of the call implied in the convertible you sold, or something whose delta is reasonably close to such a position.  But CHS decided to go one better.  They seem to have entered into what looks suspiciously like a pretty plain-vanilla forward – which of course implies a much higher delta – perhaps disguised with some fancy bells and whistles.  The problem is, as most finance geeks know, you don’t hedge a short call option with a nominally-equivalent long forward.  If you do, you end up with nothing but a short put position.  CHS, in other words, by selling a convertible and buying a forward have effectively sold both debt and a put option on their own shares.

This is most certainly not a hedge.  On the contrary, it is a doubling up of your own bet – you make money if things go well, but if things go badly you double your losses.  I am only guessing about all this because the information in the various newspaper accounts is not terribly complete, but if my sketch is anywhere close to the truth, it is not a surprise to me that the market sold CHS down 30%. 

The aim here is not to make a big deal of CHS’s exposure, but rather to point out that nearly every derivatives “hedge” I have seen recently has turned out to be little more than a speculative bet that had nothing to do with the company’s underlying business.  Six months ago I was talking about the losses associated with the euro-inversion option many Chinese companies purchased, and now a company has been implicitly selling put options on its own stock – these range from useless to actually negative as far as hedging strategies go. 

I am sure there is a lot more of this stuff hidden under various rugs.  In my experience, whenever we suddenly start seeing a spate of unexpected financial losses like this, it suggests that a lot of companies in one way or another were making the same liquidity bet – go long stuff that tends to outperform in a rising market flush with liquidity – and unfortunately these bets all tend to go wrong at the worst possible time; where to buy viagra online. They also indicate more serious underlying problems in the various corporate and banking portfolios. 

After all where to buy viagra online, if lots of managers thought this was a good bet to make with derivatives, why should we doubt that a lot of loan officers also liked similar implicit bets?  Remember that in 1989-91 when the Japanese banking system was crashing with bad loans, Japanese corporates were getting smacked by all the bad zaitechu losses.  This was not an isolated incidence of bad luck.  These almost always go together.

Of course the stock market drop was not just all about hidden liquidity bets.  Part of the weakness in financial stocks also comes from more expected cuts in mainland interest rates, especially on mortgages.  The government is in a frenzy to stop the decline in real estate prices.  They have encouraged officials at the provincial level to engage in a whole lot of measures to prop up property prices, and at a more macro level they are planning to cut mortgage rates and lower the minimum deposit required to buy first homes. 

Lowering the minimum deposit for house purchases, my astute readers will realize, is similar to the stock-market measures announced three weeks ago allowing companies to issue bonds to purchase shares, and allowing margin purchases of stock. All of these involve trying to support prices by allowing riskier buying strategies – i.e; where to buy viagra online.more leverage.  Where to buy viagra online: the rest of the world seems to think that the best solution to their problems is to deleverage, but here we are leveraging up buying power.  If the problem here turns out to be small and manageable, this strategy will look very smart.  Where to buy viagra online: if it is worse than we expected, thise strategy will force greater adjustment and more deleveraging.

Xinxin Li at the New-York-based Observatory Group released an interesting report yesterday on Beijing’s moves to boost the property market.  He lists and extends the following three:

¨          Housing transaction taxes and fees were cut at the margin.  The real estate contract tax was reduced by 0.5 percentage point to 1%.The stamp duty tax was cut from 0.05% to zero. 

¨          Starting October 27, the interest rate floor on mortgage loans will be reset to 70% of the benchmark lending rate from a level of 85%.  Given that the current benchmark lending rate is 7.47% for a 5?year term or beyond, mortgage interest rate will be cut by about 112bp. 

¨          In addition, the minimum down payment will be reset to 20% from 30% for the first residence.  The down payment ratio for a second residence was kept unchanged at 40%. 

He is not terribly optimistic that these moves will have much impact, writing that “despite these seemingly bold measures, however, we believe that they may have limited effects in stimulating demand and holding back the ongoing price corrections.”  The best the government can do, he thinks, is to slow down the housing price correction, not reverse it, and in my opinion this may actually cause more medium-term pain than a fast correction, although I suspect that we are going to see a two-tiered correction.  The formal banking system will correct Japanese style, without sudden liquidations and over a longer period, and with more wasted capacity, whereas the informal banking sector will correct much more quickly and involve liquidations.  I don’t really have any idea of how this resolves itself because I don’t have much historical knowledge of corrections in a system with such a heterodox banking system as China’s.

Let me allow Xinxin his own words as to why he isn’t terribly optimistic:

¨          Due to extremely loose monetary conditions in the past few years, excess liquidity and housing speculation have already created a significant real estate bubble – where to buy viagra online. Official figures show that prices have at least doubled since 2004, making property unaffordable for a large share of households in many big and secondary cities.  The housing price-to-income ratio in these cities remains above 10, while even at the peak level of the latest US housing bubble, the same ratio in many US cities was around 6-8.  Given the deteriorating external and domestic environment, this housing bubble may come to an end. 

¨          Now the market consensus is that average housing prices will drop by at least 20% before real demand picks up.  This 20% sounds dramatic, but a 20% drop would return prices to the level prevailing in late 2006 and early 2007.  In comparison to still-high housing prices, the marginal drop in transaction and mortgage payment costs still are quite limited steps; where to buy viagra online.

¨          From the policymaker’s perspective, the most difficult challenge is how to deal with market expectations.  If potential buyers are expecting that both housing prices and interest rates will drop further, why don’t they hold back and delay home purchase plans for a few more quarters?

¨          Moreover, there is an oversupply problem in many regional housing markets.  It is reported that in the aggressive housing expansion, real estate developers have accumulated as-yet-incomplete housing projects of 1.1bn sq meters, equivalent to China’s housing supply in the past two years.  This means it may take a couple of years for the housing market to absorb the excess stock of land and housing projects. 

I won’t quote the rest of his research report but recommend that anyone interested talk directly to him about it.  Getting the property market right is going to be key to understanding what happens next in China’s economy and financial systems.

I want to mention three other things before closing.  First, the further restructuring of the Agricultural Bank of China prior to its IPO was announced last week.  Central Huijin (a sub of the CIC) will inject $19 billion in capital in the form of equity into the bank.  I believe these will be in the form of US dollars, and ABC will not be able to convert them into RMB. 

In addition the government is creating a fund that will be managed by ABC and the MoF which will pay about $120 billion to purchase all of ABC’s NPLs.  These represent about one-quarter of the bank’s total loans but, lest anyone think the bank will emerge from this clean as a whistle, there is a lot of disagreement about whether Chinese bank NPL classifications are strict enough.  Most analysts worry that there is a lot more garbage in there, under gentler classifications, and this will become especially evident in a downturn.

If the NPL purchase (at face) is funded in the same way as the other AMC purchases, it will be funded by the purchasing fund via a bond issue guaranteed by the MoF.  I am not sure what the recovery value of these loans is likely to be, but as I understand they consist mostly of a lot of very small loans to bankrupt farmers.  One friend who understands these things better than I do says he thinks they will be lucky to get 10 cents on the dollar, and may easily get less than 5 cents.  I think NPLs at the other AMCs, which are generally considered to be of much higher quality, collected an average of 22 cents on the dollar on those portions that were sold or liquidated, but much of that consisted still of the best of the NPLs in the portfolio.

I mention this because of course the uncollectible portion should be added to the government’s debt when we calculate the total obligations of the government.  On a related note, recent government data releases show that fiscal revenue growth slowed sharply in September as corporate taxes declined and tax benefit measures increased, so that in the past two months the fiscal balance has swung into deficit (RMB 19 billion in August and RMB73 billion in September).

The second thing I wanted to say before closing is that I haven’t mentioned in a long time that one of the few blogs that I read religiously is Brad Setser’s blog.  The October 21 entry (The End of Bretton Woods II) is a particularly good entry and of obvious interest to anyone interested in China’s position in the macro-economy.  I am thoroughly convinced that it is a waste of time trying to figure out what is going to happen to China without placing it in the context of the unraveling of the old global balance-of-payments relationships and the evolution towards a new one.  China was a fundamental part of global imbalance (indeed the US-China relationship was at the heart of it), and any meaningful change will require both countries to adjust their relative positions sharply.  Brad’s blog is required reading if you want to try to figure this out.

Finally, and more as a way of introducing a little humor, let me mention a statement by Thailand’s Deputy Prime Minister, Olarn Chaipravat, about the recently completed Asia-Europe Meeting (ASEM).  “The message of this initiative” he said earlier this week, “is for China to consider whether or not China would open up its banking system and allow the strongest currency in the world, which is the Chinese yuan, relative to anybody, to be the rightful and anointed convertible currency of the world.” 

It is perhaps a little too easy to take potshots at world leaders who discuss economic and monetary issues, but I found these comments to be particularly funny.  It was always unlikely that China would open up its banking system and allow the currency to become fully convertible in such treacherous times, when it has steadfastly refused to do so when both its own economy and financial system were in better shape and the global environment was a lot more benign.  Doing so now would almost certainly cause a domestic financial collapse – where to buy viagra online. More importantly where to buy viagra online, the RMB is only “the strongest currency in the world” if you consider it to be the most undervalued.  The RMB’s rise is a function largely of its having been undervalued for so long that it caused serious monetary headaches domestically. 

Not surprisingly, the final statement issued by the 7^th ASEM contained no such revolutionary new proposals.  I think the most striking thing about it – but hardly unexpected – is that China and Asia are apparently falling behind European proposals for greater regulation of the global financial system. 

This was an inevitable consequence of the crisis – every financial crisis in modern history (and pre-modern, I suppose) leads to the same calls for stricter policing of the banks and brokers, and a ferocious attack on the structures and securities that were at the heart of the crisis, but no real discussion of what links the most recent financial crisis to the hundreds of almost identical crises that have come before it.  Where to buy viagra online: nothing changes.  It is as if this is the first time we have ever seen a financial crisis, and since this is also the first time we have seen the explosion in sup-prime loans, the surge of complex derivatives, and off-the-charts compensation for young traders, then it is pretty obvious that one caused the other.

Of course the most fun part of the aftermath of the crisis is the accompanying demand that the guilty, meaning anyone involved in the financial system, be punished.  On my flight back from Shanghai Wednesday I reread Charles MacKay’s “Extraordinary Popular Delusions…” and came upon this passage about events nearly 300 years ago:

The state of matters all over the country was so alarming, that George I shortened his intended stay in Hanover, and returned in all haste to England.He arrived on the 11th of November where to buy viagra online, and Parliament was summoned to meet on the 8th of December.In the mean time, public meetings were held in every considerable town of the empire, at which petitions were adopted, praying the vengeance of the Legislature upon the South Sea directors, who, by their fraudulent practices, had brought the nation to the brink of ruin – where to buy viagra online.Nobody seemed to imagine that the nation itself was as culpable as the South Sea Company; where to buy viagra online.Nobody blamed the credulity and avarice of the people – the degrading lust of gain, which had swallowed up every nobler quality in the national character, or the infatuation which had made the multitude run their heads with such frantic eagerness into the net held out for them by scheming projectors; where to buy viagra online.These things were never mentioned.The people were a simple, honest, hard-working people, ruined by a gang of robbers, who were to be hanged, drawn, and quartered without mercy.

Punishment was as important as repair, and new measures to ensure that such a calamity would never again happen were, everyone agreed, vital. After the appropriate rogues were identified and punished where to buy viagra online, Parliament subsequently passed a whole series of laws to make sure no such thing ever happened again, including making it more difficult than ever for corporations like the South Sea Company to come into existence (retarding, in the opinion of most historians, the development of the Industrial Revolution), and I am pleased to say that the new rules were brilliantly conceived and England never again to this day has suffered from a financial crisis.

Just kidding.  England continued to suffer from financial crises as regularly as ever where to buy viagra online, even though each crisis brought out a new group of suspect causes that were subsequently eliminated. This time around after we’ve assigned blame we’ll have the same flurry of regulatory activity to protect ourselves from financial instability in the future.  And, weirdly enough, we will continue to have financial crises.  Where to buy viagra online: i know this sounds a little pessimistic, but history makes pessimists of us all.

Fortunately the next round of regulations probably won’t do as much harm as they have in the past, especially if it results in greater transparency and more flexibility in allowing innovation to occur within the regulated system, instead of forcing it to occur outside (although I guess I am doubtful the latter will happen).  If the new global regulations do achieve these two ends, the world’s financial systems will better function during the good times.  However even with these excellent measures they are no less likely to be susceptible in the future to renewed financial crisis. 

This is because the next crisis will inevitably be caused by another period of rapid liquidity expansion, during which time financial institutions will accommodate themselves to the excess liquidity by taking on increasingly risky structures, and in order to do so they will either innovate around the regulatory constraints, grow outside the regulated system, or lie.  This always happens, and will happen again.  But I guess that at least we can all rest happier knowing that the next crisis won’t involve sub-prime mortgages.

Speaking of Maginot lines, according to Reuters today during the ASEM meeting “Sarkozy has told Chinese President Hu Jintao that he fears the United States, which is wary of excessive regulation, would be content if the summit produced ‘principles and generalities,’ according to a French presidential official.”  I read the final ASEM release and I assume that the US is content.  My cynical Chinese friends in government tell me that because ordinary Chinese are still so angry at France over the treatment of the Olympic torch, Sarkozy is eager to build trench camaraderie with China. Bring on the new global financial order – it will make everyone feel good and it might even help a little.

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The announcement that the US government would use about $250 billion of the $700 billion rescue package to re-capitalize the largest US banks is in line with actions by other European governments, and will reduce some of the credit pressure on the banks.  That’s a good thing, even if it turns out not to be enough. A lot of people are calling this move unprecedented, and representing a major change in the institution of financial capitalism in the US, but to me it only confirms that in time of crisis the government has been willing to change its ownership position.  I don’t have the numbers in front of me, but I believe that the current move to purchase equity stakes in the large US banks is not much bigger in real terms, and probably smaller in relative terms, than the purchase of bank stocks by the Reconstruction Finance Corporation in the 1930s.

As an aside, rumors are once again swirling around about leadership changes in the large Chinese banks and among regulators, but these rumors have been around for several months, and with everyone expecting announcements around the time of the October holidays, this seems to be happening more slowly than expected – a possible indication that leadership discussions are paralyzed by the uncertainty surrounding the crisis.  I have also heard several of my friends in the written and broadcasting media say that there are increasing constraints on what may and may not be said in the press and on TV about the international financial crisis and its possible impacts on China.

All this suggests that authorities are very nervous.  While the PBoC periodically announces that conditions are solid, the banking sector sound, and the economy slowing but still strong, the South China Morning Post reported yesterday the creation of a new very high level crisis committee:

Vice-Premier Wang Qishan will head a committee being set up to deal with fiscal uncertainties caused by the deteriorating global financial crisis, according to an official source – accessrx.com review. Accessrx.com review: the decision to set up the committee is the latest step by mainland authorities to try to prevent the domestic economy following western countries into recession.

At the end of the Communist Party Central Committee plenary session on Sunday accessrx.com review, the leadership said that despite the international turmoil, the mainland’s basic economic situation had not changed.However accessrx.com review, precautions to guard against the side effects of the international slowdown were needed.The source said the central government believed “losses from the international financial crisis are limited and the country’s risk and exposure to the crisis is still controllable”.

The new committee will be at the core of efforts to deal with the international problems – accessrx.com review.It will monitor financial changes overseas and respond by adjusting mainland economic policies when necessary.

It is definitely a good idea to create a high level crisis committee to monitor risks and to formulate policies for a rapid response accessrx.com review, but if the thinking really is that the main risk to China is of contagion from international exposure, I am a little puzzled. 

To me the real risk has always been that the same excess monetary expansion that led to overextended and vulnerable financial systems abroad will have done the same thing in China.  In other words the risk was not so much (in my opinion) that there was a huge amount of hidden exposure to sub-prime mortgages or some other foreign toxic waste that will bring the Chinese banking system down, but rather that we have our very own time bombs hidden in the various formal and informal parts of the domestic banking system and that any sufficiently large adverse shock – financial or economic or even political – can cause a sharp contraction in the banking system. 

The fact that the authorities seem much more obsessed with the direct contagion impact – and that the media may have been instructed not to discuss these issues too openly – makes me wonder if there is not a lot more here than I at first imagined. I am surprised that there has been so little debate within China about whether or not the crisis presents a huge buying opportunity for China (the foreign media has been much more excited about discussing this).  Could it be that SAFE and the CIC already have such a mess on their hands that no one has any intention of buying more assets abroad for a long time?

This is all just speculation, of course; accessrx.com review. The real news yesterday was the release of PBoC reserve numbers, but as an indication of how furiously busy things have been, it was only by late today that I have been able to look at the numbers. After going through the numbers and talking to my friend Logan Wright, who keeps sharp tabs on the PBoC, I have to say that there are two easy conclusions from the latest release – accessrx.com review. First, hot money inflows have almost certainly slowed and maybe even reversed.  Second, the data is getting fiendishly hard to interpret, just as we are most eager to get a little clarity.

Headline reserve growth was $96.8 billion in the third quarter. This is an extraordinarily high number by any standards accessrx.com review, but it is a measure of how out-of-control reserve growth has been in China that it is being seen by researchers and the press as a serious moderation in reserve growth. Once again (as in the good old days before hot money hijacked the process), most of the reserve growth is fully explained by the trade surplus (which soared in the third quarter of 2008) and FDI, which was higher than average for the last few years but lower than the first two quarters (much of it puffed up by anticipated investment – a nicer name for a form of speculative inflows).

However there is a lot of confusion in the numbers.  Currency valuation changes during the quarter, especially in August, added a lot of volatility to our analysis – accessrx.com review. We can only guess at the currency composition of PBoC portfolio accessrx.com review, so unfortunately even small errors in our estimate are going to have a magnified impact on our final numbers.

There were also some strange goings-on in the dollar account at the PBoC account which, following my previous usage (although the name is no longer fully appropriate) I have put in the “Reserve hike” account.  I won’t go into too much detail here because the numbers aren’t big enough to change the conclusions.

The results of my calculations, with input from Logan Wright, I have listed in the table above.  Don’t focus on the absolute numbers because there is a lot of possible error in the numbers.  What seems pretty certain is that the huge unexplained inflows of previous months (a proxy for hot money and its various close relatives) have all but vanished by July and August and in fact have probably turned into outflows by September.

Should we worry?  Yes and no. Obviously since China was, and still is, suffering from explosive monetary growth, and it is precisely this monetary growth that is creating so much risk in the domestic financial system, the fact that hot money inflows have slowed and may have even reversed is unquestionably a good thing, especially as the trade surplus has surged – accessrx.com review. Make no mistake accessrx.com review, however – having reserves rise by roughly $100 billion in a single quarter would in any other time or country be seen as outlandish.  If we eliminate non-monetized components of this increase in reserves (interest income and currency valuations), there were net inflows into the country of $120 billion that had to be purchased by the PBoC with a combination of currency and PBoC bills. 

This is more than twice the $60 billion quarterly average of 2006 – a number which once seemed astonishing.  This is a lot of domestic money growth.  Fortunately for the monetarists out there (but not for those who fear that the economy is slowing too quickly) it seems that the banks are not eager to expand loan volume too quickly.

But there is something about the latest PBoC numbers which should indeed cause worry.  For me one of the bad-case scenarios that we have most to worry about is a sudden reversal of hot money inflows, large enough that it puts liquidity pressure on the formal and informal banking systems. This is clearly not a problem yet, but the shift in a matter of months from massive inflows to moderate outflows is not confidence building.

As a related aside, and I am now straying into areas about which I need a lot more information, by coincidence I had two meetings yesterday – one with a world famous Harvard economist and a group of PKU professors, and the other with a group of traders and bankers – in both of which South Korea suddenly became the topic of conversation – accessrx.com review. I am no expert on Korea but the kinds of things I was hearing raised all my Latin-American-bond-trading hackles. One of the academics said he thought that Korea would come under tremendous liquidity pressure in the next three months. If there are problems once again in Korea I would lay pretty serious odds that capital flight will become a serious problem all through East Asia.

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What’s going on with the banks?  A lot of recent attention has been focused on Chinese banks’ exposure to Lehman and other collapsing US credits; bug viagra online. The nominal numbers being reported are relatively small compared to the bank’s capital base and earnings expectations, but there are persistent rumors that the reported exposure understates the extent of the problem.  That would not be a surprise to many of us.  A Peking University professor who I was talking to yesterday said emphatically: “Do not trust any number the banks submit.”

I am not sure if I am as negative as he is, but coincidently today I had lunch with one of my graduate students who spent the summer working in the treasury department of a large city bank whose name, for obvious reasons, I cannot mention.  He told me that one of the discoveries that surprised him during his time there was the sheer amount of fake bond trades engineered to raise trading volume numbers. A bank will sell a large volume of bonds today to another bank at some market-related price, with the agreement that the buyer will sell them right back tomorrow at the same price – bug viagra online.

Although there has been little economic change as far as the transaction goes – the bonds were merely temporarily “parked” – both banks get to report higher trading volume bug viagra online, which is necessary for them to retain their dealer licenses with the PBoC. How much of the total trading volume is fake, I asked him – 10%, 20%….50%?  I think much more, he said; bug viagra online. 

I don’t know how widespread this is – he said the dealers in his bank claim it is very common – but it does suggest that the government bond and money markets are a lot less liquid than we might think. This might not matter much for now, but it does suggest that, in a bad market, prices may be a lot more volatile than we would hope and liquidity tighter.

At any rate I have absolutely no idea if the rumors of understated exposure to bad US credits are true, but today Market News International, which tends to have very accurate inside sources in Beijing, had an article titled “Government Concerned Banks More Exposed to Wall St; bug viagra online.than Disclosed”. The article cited statements by unnamed sources who claim that the Ministry of Finance “has already held at least one meeting to discuss a proposal that would involve the sale of treasury bonds to raise funds for a cash injection.”

Although the article claims that nothing has yet been presented to the State Council bug viagra online, who would probably have to approve any such proposal before it could be enacted, it is interesting that in spite of all the soothing noises about healthy banks and limited exposure the government is so worried.  Bug viagra online: perhaps they are only taking precautionary steps, with little expectation that they will ever need them. If that is the case, needless to say, it certainly is a good thing; bug viagra online.  Bug viagra online: well-thought-out precautionary plans seem to have been in very short supply among both US and Chinese officials in recent years.

The most interesting news today, from my point of view, was the release of a report by Fitch ratings on the Chinese banking system. The report, prepared by Fitch’s Charlene Chu, argues that Chinese banks are starting to show the first signs off stress and makes the point – obvious to most of the smart folk who read my blog – that what looks good during great credit conditions can easily look a lot less healthy in a less welcoming environment. 

The steadily declining NPL ratio of recent years, for example, has been caused largely by surging loans, but a surging loan market can hide serious credit problems that only emerge during a slowdown, and Fitch claims to see increasing evidence of borrower stress among smaller companies (although they are quick to point out that they are only seeing the beginnings of stress).  They also point out that overdue loans, after declining steadily for many years, reversed course this year to show a 31% jump, from December 2007 to June 2008.  Every single bank of the twelve they monitor except one (Huaxia) showed large increases.

Granted, overdue loans of RMB 187 billion may not be much compared to the overall loan portfolio, and is only 2% higher than the December 2006 figure, but in China we need to be far more focused on the trends indicated by the proxies than by the proxies themselves.  The point is that in the first half of the year, when the economic stress was much lower than it is today and probably even lower than it is likely to be next year, one measure of credit deterioration rose sharply.

Fitch also mentions one of the things I discussed in a blog entry three weeks ago – the repackaging of loans into wealth management products.  Fitch says it is difficult to track these transactions, but they believe that about RMB 50-100 billion was done in 2007, mostly in the second half, whereas as much as RMB 315 billion was done in the first half of this year.  This isn’t large in absolute terms – I am guessing equal to just over 2% of new loans extended – but it confirms my suspicions that off-balance sheet lending (by which I include lending in the informal banking sector) has surged in recent quarters.  They also refer to something I had heard of but knew little about – what they call “entrusted lending on behalf of third parties” – which has also grown substantially. Aside from the fact that Fitch – like me – worries whether these are truly off-balance sheet when things turn ugly bug viagra online, it shows that there is an awful lot more leverage on both sides of corporate and household balance sheets than we think.

There is a lot more in the Fitch report, and it is certainly worth reading, partly because it is one of the first in what I expect will be a series of increasingly nervous reports by other firms on the banking system.  The report concludes with:

After years of stable, strong economic growth and a benign credit environment, Chinese banks appear to be approaching their first real test of resilience since starting to operate more fully on commercial terms. How trying this test will prove to be, and how banks ultimately will fare, remains to be seen.While China’s largest banks have achieved a remarkable amount of progress in recent years, deeper, more difficult reforms of banks’ credit culture, risk management, and governance remain in the early stages – bug viagra online.

As a result bug viagra online, Fitch continues to be quite cautious with regard to Chinese banks’ ratings, knowing that history has shown that even bad entities can look good during strong economic times.These reservations are underscored by concerns that potential future credit losses may be being under-estimated due to weaknesses in the data underlying banks’ expected loss models.

One piece of possibly good news for the banks as far as liquidity goes, but not good news for NPLs or the performance of the economy, was a PBoC household survey released today. Chinese households, according to the result of the survey of 20,000 households in fifty cities, have lower inflation expectations than before, but they are also more nervous about the economy and plan to save more (i.e; bug viagra online.consume less).  They also plan to invest less in real estate and stocks – only 13% of the respondents said they would like to buy a house in the next quarter, which struck me actually as a high number but is apparently the lowest quarterly number recorded since the series began in 1999 – bug viagra online.  Bug viagra online: i assume this increased savings means a faster growth in bank deposits.

Meanwhile a similar survey on corporations also by the PBoC was also released today, with evidence that corporations are increasingly worried about future growth.  Bug viagra online: according to an article in today’s China Daily:

Chinese entrepreneurs and bankers are concerned about a domestic economic slowdown more than before, according to a quarterly survey by the central bank in the third quarter…A survey of about 5,000 businesspeople show they have higher expectation of an economic slowdown, the People’s Bank of China said in a statement on its website.

The macroeconomic expectation index, which gauges entrepreneurs’ confidence in future economic growth, dropped sharply to 1.3 percent in the third quarter from 10.3 percent in the second quarter and 16.8 percent in the third quarter of last year.It was the lowest point since last year.

If corporations and households are both worrying about upcoming economic conditions, we may see both fixed asset investment and consumer demand slow – bug viagra online. Coming on the back of what seems to be declining global demand for exports, there is a real risk that slowing growth exceeds even the more pessimistic expectations – bug viagra online. 

On a final note, I had been meaning to discuss this last week, but the indefatigable Logan Wright of Stone & McCarthy had a very interesting piece out on September 19, “Monetary Policy Signals in the Chinese Interbank market”.  Early in his report he says:

The Chinese interbank market is turning upside down.Previously, banks avoided purchases of central bank paper if they had a better alternative for the funds, including lending out the money.Now, sterilization paper is in demand, and banks appear increasingly cautious about lending out funds, particularly to smaller companies – bug viagra online.This suggests that the central bank’s recent cut in smaller banks’ reserve requirements is not likely to boost lending growth significantly, but issuance of sterilization paper is likely to surge due to rising demand.  

I have never been convinced that the PBoC actions on credit – raising minimum reserves, for example, or imposing lending caps or changing interest rates – have had nearly as much impact on the overall credit market as many suppose, largely because of the tremendous leakage in the system, including some of the things that the Fitch report mentions. The main impact of these PBoC credit measures, it seems to me, has been to cause equivalent but opposite shifts elsewhere in the financial system that partly or wholly negate the economic impact of the original measure.

So, for example, constraining loan growth at a time when corporates demanded more loans simply pushed loan formation outside the formal banking system – and it is pretty clear that this has happened quite a lot.  Even raising interest rates for commercial bank deposits and loans altered the balance of loan and deposit demand outside the banking system in ways that limited the net impact – higher bank deposit rates encouraged depositors in the riskier informal system to shift deposits from the higher-paying informal banks to the lower paying but safer commercial banks, so that at least part of the impact of higher rates on deposits and loans was dissipated.

That is why I am not nearly as convinced as most other analysts are that one way the policy-makers can respond to a monetary contraction is to reduce minimum reserves or relax lending constraints.  I don’t think these measures have been effective on the way up, and won’t be on the way down. 

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Thursday night, the night before the intervention, the government had independently signaled its own worries about the markets by dropping the 0.1% stamp duty on stock purchases (the duty remains on stock sales) and announcing to the media that Central Huijin, an arm of the CIC, would buy shares in three of the Big Four banks (all except Agricultural Bank, which has not yet had its IPO).  Why only banks, if the goal was to support the broad market?  Perhaps in part because banks are a large part of the index and because the mechanism (Central Huijin) was already in place, but I suspect that at least part of the reason had to do with concerns about the self-reinforcing positive feedback loop between stock prices and perception of creditworthiness that was such an important part of the banking crisis story in the US; buy cialis online in usa.

I don’t think the reduction in stamp tax had much impact, but coming as it did with the stock purchase plan and the huge global rally, China’s stock markets flew on Friday.  The SSE Composite immediately shot up on opening, wobbled a bit for a few minutes, and then recovered so that within the first 30 minutes it was up 9.5%, to trade flat the rest of the day, closing at 2075.  For those wondering why it traded so flat for most of the day, remember that the Chinese markets have a 10% rule, which causes trading to stop when a stock is up or down by 10% within the trading day.  Normally, when the market trades at its limit for most of the day, the momentum is carried forward onto the next day.

Will it maintain the momentum beyond a few days?  I doubt it.  If Chinese share had declined because of liquidity issues affecting the US and global markets, I would argue that the various interventions might be enough to resolve what was, after all, “just” a technical liquidity problem. However because of fairly strict capital and investment restrictions there is very little connection between China’s financial markets and global financial markets, so it seems to me that nothing fundamentally has changed. In addition I don’t think the full extent of the international crisis has yet hit China – there are transmission lags in both the capital account and in real economic links – and so we are likely to see more problems before the crisis is safely behind us. 

At any rate my Peking University graduate student Shang Ning, being very curious, immediately decided to see what has typically happened when the Shanghai market has moved up by 8% or more in one day; buy cialis online in usa. He found five cases during the decade, two of them this year, and emailed his findings to me.  His numbers suggest that sharp upward movements are no more likely to presage future gains than to presage future reversals:   

This table proves nothing, of course, except that big upward price movements are not as rare as we might expect, and that in the past they have not been particularly good at predicting the future, but they do show how noisy very speculative markets are.  The only bullish indicator I can find is that from what I gather most analysts and fund managers are warning that the price rally is not likely to be sustained.

For all the fear and panic abroad, and the attendant urge to regulate markets more strictly, it is refreshing and a hopeful sign that in China, in appearance at least, the regulators are still determined to liberalize the financial markets – buy cialis online in usa. According to an article in Friday’s People’s Daily buy cialis online in usa, a number of regulators were pretty clear about this in a forum held in Beijing:

Undaunted by the worsening US financial crisis, partly blamed on regulatory shortcomings, Chinese regulators are pushing for more reform and speedy development of the nation’s financial sector.  “It is time to lift excessive regulatory restrictions on private sector financing, which could help boost the dynamics of enterprises as well as improve the capital efficiency of the financial industry as a whole,” said Wu Xiaoling, vice-chairwoman of the Financial and Economic Committee of the National People’s Congress, at a financial forum in Beijing yesterday.

Wu said encouraging private companies to raise money directly from investors could also help reduce pressure on the government to relax its monetary policy, which is central to the fight against inflation.

The problems facing the Chinese financial system are very different than the problems facing the US, and Fan Gang, director of the National Economic Research Institute, made the distinction very explicit at the forum:

“Much of the problem behind the US financial crisis stemmed from the excessive complexity of financial derivatives,” Fan said.But China is facing challenges of an entirely different nature buy cialis online in usa, he said.“The Chinese financial market, still at the initial stage of development, lacks effective financial tools, which has hampered the sustainable development of the market,” he said.

Fan called on decision-makers to further relax regulations to assist development of a multi-layered financial market.  “An overly tight regulatory system would not minimize risk, but would instead force us to passively shoulder the risks passed on from foreign markets,” Fan said.

Talking about reform in the banking sector, Fan also noted that the interest rate should be dictated by market forces to promote competition that could lead to innovation.  “We should make greater efforts to let market forces dictate the capital costs and introduce competition to China’s commercial banks in the hope of strengthening their capacity to withstand risks in the global market.”

Regular readers of my blog know that I have not been overly impressed either by the pace of financial reform or by policy-makers’ understanding of balance sheet risks, and my first instinct was to assume that the global financial crisis would result in reform paralysis – buy cialis online in usa.  Buy cialis online in usa: just as, I think, a lot of policy-makers misread the lesson of the 1997 Asian crisis and put into place a Maginot Line of defense that actually increased the risk of domestic imbalances, I was worried that one misreading of the current crisis is that financial power should be even more concentrated in a few large banks under direct control of the regulators.  But perhaps not.  It seems, at least as far as the forum went, that many of China’s most influential regulators don’t think so.

For all the surface calm it is pretty clear that an awful lot of policy-makers are very, very worried.  In the property market one gets a sense of deepening gloom. Saturday’s South China Morning Post had an article describing a funding concern that property developers are increasingly facing:

The mainland property market is expected to face an estimated capital shortfall of 673 billion yuan (HK$765.94 billion) this year as tighter controls on bank loans accelerate consolidation; buy cialis online in usa.  Buy cialis online in usa: beijing Normal University said in a research report on capital financing in the real estate industry that falling liquidity and weakening demand for housing deepened the industry’s predicament in the middle of this year.

It predicted the capital gap would narrow to 492.5 billion yuan if there was a significant turnaround in the property market by the end of next year – buy cialis online in usa. But the report warned that the shortfall would widen to 929 billion yuan if the market correction extended beyond next year – buy cialis online in usa.

With credit markets now effectively closed to property companies, yesterday’s land auction in Shanghai garnered a poor response – buy cialis online in usa. Three of the six sites put up for auction failed to draw any bids, which meant they would be withdrawn from sale, according to the Shanghai Municipal Housing, Land and Resources Administration Bureau – buy cialis online in usa.

Real estate, as everyone knows, is one of the Achilles’ heels of the financial sector and the one most likely, in most analysts’ opinions, to lead to a banking contraction.  My pessimism about financial sector strength in China is well-known enough to readers of my blog that they won’t be surprised to read that I believe there to be many others – overcapacity in the industrial sector leading to a sharp rise in inventory, sudden hot money outflows causing a shrinking in formal and informal bank funding, a renewal of inflation, rapidly declining corporate profitability, and slowing retail and export growth, to name a few (I am mangling my Achilles’ heel metaphor, I guess).

One consequence of the recent crisis is that it should put to sleep one of the most enduring myths of recent years – that financial crisis are largely currency crises – buy cialis online in usa. In fact most are not, and the determination of many countries, including China, to engineer policies that reduce the risk of a currency crisis has had the paradoxical effect of actually increasing domestic imbalances and so increasing balance sheet vulnerability to crisis; buy cialis online in usa.  Buy cialis online in usa: i think Russia’s example should be enough to destroy the idea that current account surpluses, limited external debt, and large reserves are a sufficient safeguard, especially if there has been rapid growth in the banking system. 

To that end there is an excellent article in last Wednesday’s Financial Times that discusses why; buy cialis online in usa. It starts out:

On paper, Russia’s economy looks to be virtually bullet-proof.With a 7.5 per cent year-on-year growth rate in the second quarter, it has the third largest foreign exchange reserves in the world, low international debt, a huge resource-fuelled trade surplus and nearly $200bn (€141bn, £112bn) stashed away in sovereign wealth funds.

Seen from the markets, however, the situation looks anything but rosy.Stock market indices stand at less than half their May peak, billions of dollars of foreign capital has quit the country and credit has all but dried up – buy cialis online in usa.Efforts by the central bank to inject liquidity are having little effect – buy cialis online in usa.“What is happening is that no one is lending to each other,” says Garegin Tosunyan, head of the Association of Russian Banks.“This is not so much a financial crisis as a crisis of trust.”

With world markets plunging, Russia’s financial sector has been one of the hardest hit by contagion from the US credit squeeze; buy cialis online in usa.On Moscow’s stock exchanges and banks, global conditions have exacerbated an existing crisis whose origin was largely domestic, emerging during the Russia-Georgia war in August.

Yes, yes, I know: Russia is not China; buy cialis online in usa. There are lots of differences between the two, including rules on capital transfers, but the point is not to say that China and Russia are vulnerable in exactly the same way but rather that the argument that high reserves, large current account surpluses, and low external debt are proofs against crisis is simply not true – buy cialis online in usa. If anyone wants to suggest that China is safe from financial instability he will need a much more sophisticated argument than that.

This entry is getting even longer than usual so I will make two other quick points before ending – buy cialis online in usa. First, I didn’t think the explosive milk scandal in China had much relevance to my blog until my friend Victor Shih made one of those comments that immediately make sense; buy cialis online in usa. He wondered why the use of melamine seemed to have started so abruptly and spread so quickly.  Buy cialis online in usa: it would have been more natural, if it was simply a “normal” case of unscrupulous manufacturers, for the contamination to have developed more slowly. One possibility buy cialis online in usa, he argues, is that the deterioration in quality is a not-unexpected outcome of recent price controls. As the cost of inputs rose faster than the price at which retailers were allowed to sell, there was more pressure than ever for manufacturers to cut costs and engage in risky behavior.

I don’t know if this is true or not, although it sounds perfectly plausible, but since I read Victor’s comment I have seen that the idea – that there may be a connection between the imposition of price controls and the rapid expansion of the use of melamine – has become very widely discussed. Traditionally price controls often lead to shortages and to cuts in quality, and perhaps the milk scandal is one of the unexpected costs in using administrative measures to fight inflation.

The second point I want to close with is a happier one.  Today’s Bloomberg says that “China, the world’s biggest consumer of grain, may harvest a record output this year after farmers seeded more land with rice, corn and soybeans, the Ministry of Agriculture said.”  If food production grows sharply, it will limit the risk of another surge in food inflation.  I do not know enough about agricultural production and food consumption to say whether the record output is enough to keep up with demand, but it’s a start.

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