Financial mutually assured destruction

http://blogs.cfr.org/setser/2008/07/12/too-chinese-and-russian-to-fail/

don’t think that owning large amounts of US debt gives China that much leverage over US policy decisions. It’s very easy to think of ways that China could destroy the US economy. It’s hard to think of ways that China could destroy the US economy without destroying the Chinese economy.

The only scenario I can think of in which China would declare “economic war” on the US would be if it felt its national survival to be at risk, and the only plausible situation in which I can think of this happening is explicit US support for Taiwan independence. The fact that the Bush administration moderated its policies toward Taiwan between 2001 and now was I think driven in part by economic considerations, but that is the only issue I can point to where US debt played a part.

One other thing that economic considerations have played a part in is that Chinese holdings of US debt have eliminated whatever small support there is for a policy of “neo-conservative regime change.” There is no way that the US could fund a major effort at destabilizing the Chinese government (and a few thousand dollars to dissidents that everyone ignore doesn’t count) since that money comes from China.

One note is that the neo-conservatives were particularly idiots at economics, and the fact that they were such idiots and self-righteous, arrogant idiots meant that no one with the slightly amount of business sense would talk to them. So they ended up financing their “war for freedom” by borrowing massive amounts of money from the regimes that planned to eventually overthrow (Saudi, Russia, and China). The only good thing about this is that it discredited them before they could start World War III.

Just like having China embedded in the world financial system and dependent on the United States was intended to keep the idiots out of power in China, I think that having the US embedded in the world financial system and depedent on China keeps the worst idiots out of power in the US. So the influence that China has on US policy (which I might add is still nowhere near the influence that the US has on China policy) is IMHO, not a bad thing. (google for the term constrainment)

Notes of China as a creditor

http://blogs.cfr.org/setser/2008/07/09/maybe-china-is-a-typical-creditor-after-all/

Huizer: as was the previous owner. In order to have ofices in the US, a foreign bank/BHC itself must comply with the Basle accords, and its domestic governance and regulation must also be in accordance with those accords.

There really shouldn’t be a major issue with this, since China has agreed in principle to the Basel accords, and I don’t see anything within the CIC structure that would prohibit it from acting as a BHC under Federal Reserve supervision.

Also there are lots of Chinese banks that aren’t owned by CIC.

One issue here is that a lot of the regulations on foreign banks operating in the US are discretionary, which gives a lot of power to the regulator to prohibit a license if they just don’t like you. Also in the case of the US, there are so many different regulators, that it’s easy for one to just say no if they don’t like you. One of the goals of WTO was to reduce this problem, and a lot of the standards that China agreed to was to reduce regulatory discretion. However, when the WTO accords were being negotiated, no one really thought about or cared Chinese banks operating in the US, so the agreements that China made in opening up the financial services markets aren’t reciprocal.

Keeping on topic (heh, heh) that might be one of the larger consequences of China as creditor in that the issue of opening up the US financial services market to Chinese banks is now on the table, whereas it was not before. The concept until this year was that US banks would be the intermediaries for Chinese savings since they were supposedly much better run than Chinese banks.

As a side note, German Landesbanks were a major buyer of mortgage-backed securities. They were required by Basel to have reserves consisting of “high quality” securities, and guess where you can get AAA bonds paying very high interest……. Ooppps….

Huizer: But that leaves the problem that these banks are, part of the same BHC.

Hypothetically, the Chinese government could split up ownership of the banks with different holding companies, however in that case, it’s not unclear that this would satisfy US regulators since the different holding companies would ultimately answer to the Communist Party.

However, this is another consequence of last years events, since last year you could argue that having Chinese banks under the ultimate control of a quasi-governmental agency was a bad thing that would automatically disqualify a bank from operating in the US, since private banks were obviously much better at risk control. You can’t make that argument now without people laughing at you.

Also, there is a spectrum of effective control among Chinese banks. There are banks that are more controlled by the Party and Central Government and banks which are less controlled by the Party and Central Government. It’s not necessarily the case that the banks that are less controlled are better run.

Looking at broader issues, the big obstacle I think is to have the US government more or less accept that the Chinese economic system in which the Communist Party makes a lot of the decisions is legitimate way of running a country. It’s not that China is explicitly trying to export its system of government, but rather there is this psychological block that says that the US can tolerate a system of government run by “evil Communists.”

There is much less of a block on the other side, since there is no psychological block that I can see for the Chinese government to adopt practices by “evil capitalists” if they can see it as being able to keep themselves in power. But there was in 1980. Coming up with theories of government which would allow China to adopt “capitalist” ideas without calling into question the legitimacy of the whole system was a major challenge.

I suppose what will come out of this is likely the notion that the United States can tolerate a Party run economy, without tolerating the way that the Party treats political dissidents, but even accepting this idea is going to require some time.

This is the only unique thing I can think about the Chinese situation. There are a lot of challenges in getting the German and Japanese banking system to work the US, but in the case of Germany and Japan, the US can accept that they are not being run by “evil Communists.”

The problem that the US faces is that if it goes the route of saying “we aren’t going to let the evil Communist Chinese set up banks in the US” it goes against a lot of the other norms that the US has stated it believes in like regulatory transparency or creation of an impartial legal system.

Huizer: In fact an interesting situation, taxing the routinely adversary lawyers mentality of US regulators in the face of foreign authorities that are skilled in not taking no for an answer and (falsely or rightly aware) that they have financial leverage.

Also if you have money, you can hire your own lawyers. One thing that is happening is that Chinese banks are very actively recruiting Chinese Wall Street bankers with deep knowledge on how the system works. There have been a number of recruiting efforts in NYC by Chinese banks, and at one of them, I was struck that the bank had recruited into its top management one of the legendary people in Wall Street.

One problem is that there is still something of a “Cold War” mentality lurking in the US, which is a problem since the issues that China is posing are ones that are very different from the Cold War Soviet Union. The Soviet Union was never in a position to set up banks in the US or to recruit high level US bank executives to run its economy, and there never was a de-facto alliance between American capitalists and Soviet Communists. The Chinese Communist Party has embraced markets and international trade in a way that the Soviets were never able to for the reason that markets generally work better than central planning, but the fact that the CCP has been market-oriented for a generation is now posing some a lot of new issues.

Huizer: he more I think of it, the spirit of assertiveness and nationalism (see also the Olympics/Tibet display of public sentiment) is probably catching on in Beijing.

It’s actually not “catching on.” Chinese have been assertive and nationalistic for the last 150 years, and popular Chinese nationalism in 2008 is actually much, much less anti-American than it was in 1994. You have people demonstrating against CNN media bias, but those people are trying to get into American schools so that they can get jobs with American companies. Also in 1994, there were a lot fewer Mainland Chinese in the US.

The reason this has come up is that people in the US had the expectation that Chinese nationalism would decline over time, when Chinese youth are probably much more nationalistic than their parents since Chinese youth today grew up in a time in which China has been rising.

The other thing that Americans are not aware of is the degree to which the ideals of “1989 Tiananmen students” have been completely discredited in China. One rough analogy to what has happened in China is a socialist hippie flower child living in the middle of the Reagan revolution. One reason for this is that the Communist Party has embraced markets and globalization, whereas their opponents have tended to be anti-market and anti-globalization (i.e. trade sanctions on China). This is a big problem since it put the Tiananmen students on the wrong side of the tide of history.

Huizer: As a non-Chinese with too little knowledge of Chinese history I would nevertheless tend to dispute claims that Zhonghua is/ has been permanently peaceful.

As a Chinese with a lot of knowledge of Chinese history, I would also strongly dispute those claims. You can write a history book in which China has been always peaceful and defensive, and that is the history book you give to elementary school students to indoctrinate them. However, there are other ways of telling the story. If your goal is to make Chinese look evil and warlike and a danger to civilization that must be crushed, yeah, you can write a history book that says that.

My own view is that to effectively advance Chinese interests in a global world, you *must* read these negative histories so that you can understand how people perceive China negatively, so that you can effectively counter those perceptions.

I should point out that I don’t think that the type of political indoctrination that Chinese elementary school students get is worse or more factually incorrect than the type of political indoctrination that American elementary school students get. One of the purposes of elementary schools of any national-state is political indoctrination.

Huizer: During periods of foreign domination (the Yuan and Qing dynasties) the abject foreign rulers forced China into territorial acquisition which the Chinese people gallantly sabotaged, but not with immediate results.

What gets interesting is when you have multiple and contradictory versions of history within the same book. In the version of history that I tell my kids, the Yuan and the Qing were not “foreign” dynasties, and the Mongol and the Manchu rulers of China were Chinese. Different Chinese, but Chinese nevertheless.

I do have some personal motives here. First is that the broader you define Chinese, the less likely it is that I’m excluded.

The second motive, is that by reading about how the Manchu rulers of China were able to be both “Chinese” and “Manchu” and how they were ultimately able to define the term “Chinese” it gives me a notion of what to do in my situation. I’ve found myself in the ruling power elite of the United States, and the strategies that I’ve ended up using to be both Chinese and American and to define what an American is are very similar to the ones that the Manchus used.

Notes on national sovereignty and SWF’s

http://blogs.cfr.org/setser/2008/06/20/chinas-sovereign-economic-development-fund/

One other thing that this illustrations is that using national sovereignty and national security has its limits. If China were thinking about buy mines and mineral rights in the United States, then sure the US government can and in fact should stop that it if doesn’t think that it is in the US national interest. However, it’s really tough for the US government to use US national security interests as an excuse to block in deal in which China buys stakes in Brazil and Australia.

In situations where you are dealing with small impoverished nations, you run into the problem that you have counterparties that aren’t able or willing to make a good deal and the problem of exploitation becomes a problem. In the case of Zambia or Uganda, you really have questions as to whether the government is acting in the Zambian and Ugandan national interest or whether they have the expertise to tell a good deal from a bad one. This definitely is not a problem with Australia, and I don’t think that it is a major problem with Brazil. Both those governments can and should say no if the deals that they are offerred are bad ones.

(Also the problem of insufficient expertise isn’t only a problem in developing countries. The state of Florida and a lot of municipalities has run into huge problems because they didn’t have the expertise needed to run some of their funds.)

Personally, the model I think that CIC should look very closely at is Calpers. However, I think that one thing that has changed in the last three months is that the financial problems on Wall Street have made the government concerned about having too little control over investment decisions.

My own thinking on these issues is very heavily influenced by Von Mises and his ideas on the socialist calculation problem, which is a very good explanation about why central planning doesn’t work for national economies.

Another point is that if CIC turns out to work well, there’s nothing that keeps the US from taking the $2 trillion in the social security trust fund and creating its SWF. I’m not worried too much about CIC “taking over the world.” I’m much more worried about CIC shooting itself.

One other way of thinking about this which tells you how much things have changed in the last few months is that you can think of the holdings of the Federal Reserve as an SWF which is invested in real estate and financial services.

Bernanke has crossed the Rubicon. The old rules are no longer constraints and everyone is busy trying to figure out what the new rules are.

More notes on the China Investment Corporation

http://blogs.cfr.org/setser/2008/06/20/chinas-sovereign-economic-development-fund/

Let’s be very clear about one thing. CIC is and for the forseeable future will be political in the sense that is will be managed in a way that serves to advance Chinese national interests as defined by the Communist Party of China, and that means that CIC will be used as a tool to increase China’s global political and economic interests. This is just a reality. The United States may not like it, but it has to react to this since there isn’t any chance that the US can change this.

What makes this an interesting project is that China is clearly acting in a way so that large segments of the United States benefit from rising Chinese economic and political power (Walmart for example), and can be expected to support it. This is very different from the behavior of Russia or even Japan. China doesn’t want its rise to be zero-sum, and this isn’t out of altruism rather than self-interest. If there is a national consensus within the United States that China’s rise must be stopped then this makes it much more difficult for China to get more political and economic power.

The question that Beijing in interested in becomes *how* can CIC best advance Chinese national interests, and there different people have different ideas. What makes this a difficult question is that some of the obvious ways of using CIC to advance Chinese interests won’t work. I’m not too thrilled about using CIC to establish control over strategic resources and very much opposed to CIC given below-market financing to SOE’s, because based on looking at people doing similar things in the past, my belief is that those activities do not aid in adding to Chinese comprehensive national power, and will end up being a drain on Chinese wealth and power. But I have an open mind about this.

In particular, my personal belief is that to meet its political goals, CIC must remain commercial in the sense of adding wealth to the national treasury rather than subtracting from it, and that things such as promotions and funding decisions be made such that CIC makes a profit, and that people be rewarded when CIC generates wealth and punished when it doesn’t. This doesn’t create large contradictions with the political goals of CIC, since there are lots of different ways of making money. If it is choice between making money with strategic resources and making money with something else, then sure, it’s alright to discuss which industry is going to help China. The commercial constraints come in when its a choice between losing money and making money.

The reason commercial constraints are important is because you end up with lots of principal-agent problems, and you don’t want to end up with a situation were CIC benefits its funded corporations and managers, but hurts the national interest. If you impose a “make money for us or we will fire you all” condition, then it makes it harder for the people running CIC to loot the company, whereas if you merely use vague concepts like “national interest” without controls, then the managers of CIC will act as if “national interest” means moving all of CIC’s money into their personal bank accounts and leaving the government with massive debts.

So in this sense, not only are “political” and “commercial” not in conflict, but the requirement that CIC make money and the desire for the Communist Party to exercise control are not in conflict, since the requirement that CIC make a profit provides a means by which the Communist Party can exercise control over the management of CIC and align the interests of the management with the interests of the Chinese political leadership. The policy here is “if we get money and power, you get money and power.”

The reason business and economics is vitally important is that the Chinese strategy for getting money and power requires that the game be non-zero sum. If more money and power for me means less money and power for you, then we can’t rationally cooperate, but if money and power are generated (which is the goal of business), then we can work in ways that help both of us.

Having two groups of people stare each other in the eye and figure out how they can based interact in a way that benefits them both is almost the definition of commercial.

How Biofuels Could Starve the Poor… Not….

http://www.foreignaffairs.org/20070501faessay86305/c-ford-runge-benjamin-senauer/how-biofuels-could-starve-the-poor.html

http://blogs.cfr.org/setser/2008/06/05/really/

Personally I think that the Runge and Senauer paper is non-sense. It ignores the fact that most people in developing countries are food producers (i.e. peasant farmers) and not food consumers, and so that rising food prices are a *good thing* since they will be able to sell their crops at a higher price.

High food prices do hurt the urban poor, but since the urban poor are the first to riot, developing world governments tend to keep them busy and well fed.

One might want to read “The Road to Hell: The Ravaging Effects of Foreign Aid International Charity”. The book argues that food exports to the developing world are generally a bad thing, since they leave the developing world dependent on agri-business and also put lots of farmers out of work. One should note that the policy agenda of the developing world at the WTO has been to get developed countries to *reduce* subsidizes for agricultural production.

This has some impact on Chinese decision making. One thing that I’ve noticed is that the Chinese government doesn’t seem to be making food inflation a huge priority and that is largely because by letting food prices rise and fixing prices of oil and fertilizer, you have wealth going into rural areas which is the number one priority of the Chinese government.

One other thing this points out is how complex economic decisions really are.  One thing that I’ve noticed is this generalization in which you point out how biofuels are hurting some poor people and from these situations one assumes that biofuels and high food prices hurt all poor people, which they don’t.  If you are a poor urban dweller, then yes high food prices will hurt you.  If you are a poor farmer, then high food prices will help you.

One thing I do before I write something is to do a quick google to do a fact check, and the nice thing about doing this is that I usually learn something new in the process.  For example, the reason I wrote some of this was because I was reading in Bloomberg magazine about the riots in Haiti over higher food prices, and how this proves that biofuel subsidies are destroying to poor of the world.  So to justify my statement that most poor people in the world are farmers, I did a quick google check, and what I found was quite interesting.  Most poor people in the world are farmers, but I was struck at how different the economies of the world were from each other.  For example, most people in China, India, Mali, and Mozambique are farmers, but most people in Peru, Algeria, and most significantly Haiti, aren’t.

Here is a map that I found….

http://www.fao.org/es/ESS/chartroom/gfap.asp

One thing that this does tell you is how extraordinarily different the economies of different places are, and how generalizations about things will or won’t work have to be made very carefully.

Notes on the IMF and its role (or lack thereof) in current economy

One basic principle of “getting things done” is that authority and responsible have to be matched. If you make someone responsible for doing something, then you have to give them authority to do it. If you what to give them authority, then you better make them responsible for the consequences.

In the case of currency exchange rates, making Treasury responsible for it is silly if you want anything done, because they have zero authority to do anything that might actually change exchange rates.

Now the Federal Reserve *does* have authority to set exchange rates. The curious thing is that it has no responsibility to do so. Under the Humphrey-Hawkins Act, the responsibility of the Federal Reserve is to maintain growth and minimize inflation. The interesting thing is that currency exchange rates isn’t mentioned, and even more interesting neither is balance of trade.

Part of the reason this is the case, is that under Bretton-Woods the institution that maintained exchange rate stability and balance of trade was the IMF, but they have basically self-destructed and become completely irrelevant in global economics. The only real power that the IMF had after the collapse of Bretton-Woods was the power to grant or withhold funds in a currency crisis, but they used that power so badly in the 1990’s that everyone has created these huge reserves, at which point the IMF became irrelevant.

Subprime mortgages and food prices

In economics everything is connected with everything else, and the difficulty is to figure out the connections.

Right now I’m trying to figure out

subprime mortgage collapse -> **** -> rising global food prices

One problem here is that I’m not a farmer so I know nothing about the economics of agriculture.  In particular, I don’t know how a farmer interacts with the credit markets.

Michael Pettis has argued that the inflation in China is due to monetary policy, but the one thing that makes me suspect that there is much more to the story is that it isn’t obvious why RMB exchange rates should increase food prices in Haiti.

Climbing Mount Nebo and reading Chinese GDP figures

One odd thing about globalization is that you end up with different ideas hitting each other.  Every time I read GDP projections about China, I always think about a passage from the Bible in Deuteronomy 34, which I learned when I was very small.

34:1 Then Moses went up from the plains of Moab to Mount Nebo, to the top of Pisgah, which is opposite Jericho. And the Lord showed him all the land, Gilead as far as Dan 2. all Naphtali, the land of Ephraim and Manasseh, all the land of Judah as far as the western sea, 3 the Negeb, and the Plain, that is, the Valley of Jericho the city of palm trees, as far as Zoar. 4 And the Lord said to him, “This is the land of which I swore to Abraham, to Isaac, and to Jacob, ‘I will give it to your offspring.’ I have let you see it with your eyes, but you shall not go over there.” 5 So Moses the servant of the Lord died there in the land of Moab, according to the word of the Lord,

Even given the most optimistic growth rates, the GDP and standard of living of China is not going to reach developed world status until at least the second half of the 21st century.  With all of the talk of China’s rise, people forget these constraints which were known by Deng Xiaoping when he started all of this in 1978.

The result of this is that I can see the promised land, but I’m not going to ever live in it.  It’s interesting to be part of a massive historical drama that started long before I was born, and is going to continue long after I die.

Random trivial but important fact about European banks

http://www.nytimes.com/2008/04/02/business/worldbusiness/02ubs.html?hp

One  random bit of trivia about European banks like UBS and Deutche Bank is that they report earnings six months after the fact rather than American banks that report earnings three months after the fact.

Financial regulation

And now for something really different financial regulation in the United States.

It seems to be odd that there are already detailed plans for how to change financial regulation in the United States, without a discussion of some pretty fundamental questions:

1) Why are we regulating? Is it to protect consumers? Is it to insure that “bad guys” be punished? Is it to deter future “bad guys”? Is it to prevent a collapse of the financial system?

All of these are legitimate reasons for regulation, but they may cause contradictory policy. For example, a system that focuses on punishing bad people is often too late to protect consumers.

Once we have an idea of what the bad thing is we are trying to prevent, then two questions follow

2) Who are the new regulators? What is the role of the Fed, the SEC, the Office o Thrift Supervision, etc??

3) What do we regulate? Is the purpose of regulation to provide information? To prevent bad behavior? to prevent risky behavior?  to save people from themselves?