A good discussion about the economic challenge China is facing. (This is a 35 mins radio show with Tom Ashbrook, host of On Point).
Archive for January 11th, 2009
With the 3-year lockup period expiring, Western banks are selling their stakes in Chinese banks to fill the hole on their own balance sheet. Chinese banks are rethinking their development strategies (source: WSJ):
Decisions by Bank of America Corp. and other institutions to sell down their stakes in Chinese banks signal more trouble for Beijing’s strategy of using foreign expertise to build a world-class banking system.
Since 2005, foreign financial institutions have pumped more than $25 billion into Chinese banks as part of a grand bargain engineered by Chinese regulators. Foreign investors would gain access to China’s banking market and in return teach Chinese banks how to operate profitably.
But the momentum for cooperation has been slowing. Now foreign banks, desperate to replenish balance sheets weakened by the global financial crisis, are starting to cash out.
On Wednesday, Bank of America trimmed its holdings in China Construction Bank Corp. to 16.6% from more than 19%, selling 5.6 billion Hong Kong-listed shares in a placement that raised $2.8 billion. In November, Bank of America paid $7 billion to almost double its stake in the Chinese bank.
Meanwhile, a foundation established by Hong Kong’s wealthiest tycoon, Li Ka-shing, is selling two billion shares in Bank of China Ltd. to raise as much as $524 million for the charitable group, according to a term sheet. A spokesman for the Li Ka Shing Foundation noted that the foundation still holds three billion shares in Bank of China, which “are part of our long-term holding and won’t be sold for a long time.”
Last week, UBS AG sold its entire 1.3% stake in Bank of China Ltd. for $808 million.
Banking analysts believe that other foreign banks are planning to unload stakes, though they say that such sales don’t necessarily point to problems in the relationship with Chinese partners. Bank of America and China Construction Bank have had one of the better relationships, analysts said.
Since taking its initial stake in 2005, the Charlotte, N.C., bank has assigned about 60 employees to work with China Construction Bank on an array of projects, from revamping its technology systems to updating branches to improving communications strategies, according to Bank of America spokesman Robert Stickler.
“We definitely will continue to be a long-term major shareholder of CCB and a long-term strategic partner,” Mr. Stickler said. “The fact that we sold a few shares doesn’t change that.”
Last month, Bank of America called off a similar sale, prompting speculation that it held back for political reasons. But Mr. Stickler said that wasn’t the case then, or now. “We have a very close relationship with CCB management and the Chinese government,” he said. “Nothing we were doing was a surprise to them.”
Investments by foreign banks with global reputations eased the way for Chinese banks to successfully list their shares overseas in 2005 and 2006. But three-year lockup periods, during which foreign investors weren’t allowed to sell their shares, are expiring.
The scramble to exit highlights the difficulties of Chinese-foreign banking partnerships that have suffered from mismatched expectations. Holger Michaelis, a partner at Boston Consulting Group in Beijing, said a major letdown has been technical assistance, such as with risk-control systems.
Chinese bankers are often frustrated by foreign advisers who have rich international knowledge and experience but can’t solve local problems because they don’t understand local conditions. That is altering Chinese bankers’ expectations that foreign advisers can offer immediate solutions, Mr. Michaelis said.
Some foreigners have bristled at their limited influence over bank operations and inability to gain ownership control. For years, foreign strategic investors have been anticipating a lifting of the 20% cap on foreign stakes in Chinese banks, but that hasn’t happened.
And there has been rivalry. In 2007, Bank of China announced an “exclusive partnership” with Royal Bank of Scotland Group PLC’s private-banking arm, only to start its own proprietary wealth-management business later.
Unlike many of their Western peers, Chinese banks have had relatively little exposure to subprime-mortgage-related assets or agency debt, issued by entities such as Fannie Mae and Freddie Mac. That puts them in a better position to weather the global financial crisis, despite the slowing Chinese economy.
Zhao Xijun, the deputy director of the School of Finance at Renmin University of China, doesn’t believe the foreign sales represent a wholesale retreat. “Undoubtedly, foreign banks will continue to expand their footprints in China,” he said. “But they will be more focused on developing their own business rather than buying into a Chinese lender.”
Until five years ago, Chinese lenders were considered technically insolvent. After a cleanup that cost the government an estimated $500 billion, foreign strategic investors took the plunge. Three of China’s four largest commercial banks — ICBC, Bank of China and China Construction Bank — have since gone public overseas.
At the time, the thinking was that foreigners would help improve Chinese management standards, transfer technology and know-how, and co-build new fee-earning businesses such as credit cards and wealth management. One of the most urgent aims was to fix a weak link in the local banking system: risk governance.
Still, banking analysts said, Chinese regulators are debating what benefits can be gained from Western financial institutions rocked by the financial crisis. “Definitely, there is a rethinking among [Chinese] banks, insurance companies and asset-management companies as to what is the best model for the long term,” said Kang Yan, a partner at Roland Berger Strategy Consultants in Beijing.
WHEN the Obama administration finally unveils its proposal to get the economy on the road to recovery, the centerpiece is likely to be a huge increase in government spending. But there are ample reasons to doubt whether this is what the economy needs.
Arguably, the seeds of the spending proposal can be found in the classic textbook by Paul A. Samuelson, “Economics.” First published in 1948, the book and others like it dominated college courses in introductory economics for the next half-century. It is a fair bet that much of the Obama team started learning how the economy works through Mr. Samuelson’s eyes. Most notably, Lawrence H. Summers, the new head of the National Economic Council, is Mr. Samuelson’s nephew.
Written in the shadow of the Great Depression and World War II, Mr. Samuelson’s text brought the insights of John Maynard Keynes to the masses. A main focus was how to avoid, or at least mitigate, the recurring slumps in economic activity.
“When, and if, the next great depression comes along,” Mr. Samuelson wrote on the first page of the first edition, “any one of us may be completely unemployed — without income or prospects.” He added, “It is not too much to say that the widespread creation of dictatorships and the resulting World War II stemmed in no small measure from the world’s failure to meet this basic economic problem adequately.”
Economic downturns, Mr. Keynes and Mr. Samuelson taught us, occur when the aggregate demand for goods and services is insufficient. The solution, they said, was for the government to provide demand when the private sector would not. Recent calls for increased infrastructure spending fit well with this textbook theory.
But there is much to economics beyond what is taught in Econ 101. In several ways, these Keynesian prescriptions make avoiding depressions seem too easy. When debating increased spending to stimulate the economy, here are a few of the hard questions Congress should consider:
HOW MUCH BANG FOR EACH BUCK? Economics textbooks, including Mr. Samuelson’s and my own more recent contribution, teach that each dollar of government spending can increase the nation’s gross domestic product by more than a dollar. When higher government spending increases G.D.P., consumers respond to the extra income they earn by spending more themselves. Higher consumer spending expands aggregate demand further, raising the G.D.P. yet again. And so on. This positive feedback loop is called the multiplier effect.
In practice, however, the multiplier for government spending is not very large. The best evidence comes from a recent study by Valerie A. Ramey, an economist at the University of California, San Diego. Based on the United States’ historical record, Professor Ramey estimates that each dollar of government spending increases the G.D.P. by only 1.4 dollars. So, by doing the math, we find that when the G.D.P. expands, less than a third of the increase takes the form of private consumption and investment. Most is for what the government has ordered, which raises the next question.
WILL THE EXTRA SPENDING BE ON THINGS WE NEED? If you hire your neighbor for $100 to dig a hole in your backyard and then fill it up, and he hires you to do the same in his yard, the government statisticians report that things are improving. The economy has created two jobs, and the G.D.P. rises by $200. But it is unlikely that, having wasted all that time digging and filling, either of you is better off.
People don’t usually spend their money buying things they don’t want or need, so for private transactions, this kind of inefficient spending is not much of a problem. But the same cannot always be said of the government. If the stimulus package takes the form of bridges to nowhere, a result could be economic expansion as measured by standard statistics but little increase in economic well-being.
The way to avoid this problem is a rigorous cost-benefit analysis of each government project. Such analysis is hard to do quickly, however, especially when vast sums are at stake. But if it is not done quickly, the economic downturn may be over before the stimulus arrives.
HOW WILL IT ALL END? Over the last century, the largest increase in the size of the government occurred during the Great Depression and World War II. Even after these crises were over, they left a legacy of higher spending and taxes. To this day, we have yet to come to grips with how to pay for all that the government created during that era — a problem that will become acute as more baby boomers retire and start collecting the benefits promised.
Rahm Emanuel, the incoming White House chief of staff, has said, “You don’t ever want to let a crisis go to waste: it’s an opportunity to do important things that you would otherwise avoid.”
What he has in mind is not entirely clear. One possibility is that he wants to use a temporary crisis as a pretense for engineering a permanent increase in the size and scope of the government. Believers in limited government have reason to be wary.
MIGHT TAX CUTS BE MORE POTENT? Textbook Keynesian theory says that tax cuts are less potent than spending increases for stimulating an economy. When the government spends a dollar, the dollar is spent. When the government gives a household a dollar back in taxes, the dollar might be saved, which does not add to aggregate demand.
The evidence, however, is hard to square with the theory. A recent study by Christina D. Romer and David H. Romer, then economists at the University of California, Berkeley, finds that a dollar of tax cuts raises the G.D.P. by about $3. According to the Romers, the multiplier for tax cuts is more than twice what Professor Ramey finds for spending increases.
Why this is so remains a puzzle. One can easily conjecture about what the textbook theory leaves out, but it will take more research to sort things out. And whether these results based on historical data apply to our current extraordinary circumstances is open to debate.
Christina Romer, incidentally, has been chosen as the chairwoman of the Council of Economic Advisers in the new administration. Perhaps this fact helps explain why, according to recent reports, tax cuts will be a larger piece of the Obama recovery plan than was previously expected.
All these questions should give Congress pause as it considers whether to increase spending to stimulate the economy. But don’t expect such qualms to stop the juggernaut. The prevailing orthodoxy among the nation’s elite holds that increased government spending is the right medicine for what ails the economy.
Mr. Samuelson once said, “I don’t care who writes a nation’s laws or crafts its advanced treaties, if I can write its economics textbooks.”
The coming stimulus bill, warts and all, will demonstrate brilliantly what he had in mind.
N. Gregory Mankiw is a professor of economics at Harvard. He was an adviser to President Bush.
Courtesy of Mike Panzner:
Yesterday, the Federal Reserve reported that outstanding consumer credit for November fell a worse-than-expected $7.9 billion, lending support to the notion that the consumer is deleveraging.
However, based on the accompanying graph of year-over-year changes in consumer credit and mortgage debt relative to GDP, it seems like deleveraging has hardly begun.