Twofish's Blog

June 30, 2006

Some excellent commentary and analysis by Stephen Roach

Filed under: china, finance — twofish @ 8:03 pm

Some excellect commentary and analysis by Stephen Roach. I happen to disagree with much of it, but its still very good commenary and analysis because it brings in different facts and perspectives onto the table.

I do think that the situation is quite a bit better than Roach seems to think it is, and a lot of places where Mr. Roach sees in a pessimistic light, I see as quite optimistic. The key thing is that I don’t think that it is a bad thing to have some tension between local and central officials. Any large country is going to have different groups of people with different outlooks and perspectives, and the key thing is that people manage to argue, debate, and work through these conflicts and get something workable in the end. And in the specific examples that Mr. Roach presents shows that this is precisely happening in China.

For example:

What I find particularly interesting is that Chinese municipalities are now taking it on themselves to issue regulations to cool off their overheated property markets; Shenzhen has taken the lead in that regard, with a 22 June announcement of ten tightening actions coming some three weeks after Beijing’s so-called administrative edicts. According to press accounts, while there was little response to the national edict, the Shenzhen residential property market has come to a virtual standstill in response to the local actions. This is an important real-time example of the tension between relatively impotent national tightening measures and the traction achieved through local actions.

What Mr. Roach seeing as national impotence, I’m seeing as a sign of the center being in charge. If you look at the actual content of the “adminstrative edict” that Roach refers to,

it was a “an opinion.” What an opinion (yi jian) is, is a general policy statement indicating the intentions of the central government and directing Chinese government bodies to develop implementation measures (ban fa) to execute the opinion. Three weeks later, local governments come up with their implementation measures, execute them, and according to Mr. Roach, they seem to be working, at least in Shenzhen. What Mr. Roach sees as “central government impotence” looks a lot like a very well oiled administrative machine in which the central government issues general directives and leaves it to local governments to figure out how to implement them. Going from general policy directive to execution in three weeks is lightning speed in the bureaucratic world.

Similarly, a lot of the other examples which Mr. Roach sees as disfunction, I see positively,

For the second time in two years, Beijing has imposed a series of tightening measures on China’s overheated investment sector. Like the “cooling off” of 2004, three sets of actions have been taken — a modest 27 bp increase in lending rates, a 50 bp point increase in the bank reserve ratio, and a series of administrative controls targeted at China’s hottest industries. However, if these measures didn’t work a couple of years ago, I doubt they will today when dollar-based nominal GDP is 35% larger and fixed asset investment flows are over 60% greater than they were in 2004.

The trouble with this paragraph is that the macroeconomic controls that the Chinese government put in place in early-2005, worked beautifully. In 2004, the Chinese economy was facing some obvious bubbles and bottlenecks, fixed asset production was exploding, and there was the whiff of inflation in the air. The government put some measures in place, the economy cooled, and as of January 2006, it looked that things were really good. (You can verify this by looking the contents of press reports from month to month). What has happened since April/May is that the fixed asset numbers aren’t going down, and so the government is coming in to cool down the economy through mechanisms which as we noted above, seem to be working. There are some worrisome numbers, but the fact that the government is now able to manage the economy on a month-to-month basis and is doing something pro-active to deal with an economic issue before it gets bad, is a really good thing.

Some more comments:

If the central bank attempts to restrict bank lending by raising interest rates and reserve requirements — as is the case at present — under the best of circumstances, a fragmented banking system can be expected to respond very unevenly.

Precisely. Which is why they aren’t trying to manage things by raising interest rates.

The public listing of state-owned banks should force a shift from locally-driven “policy loans” to commercially viable credit lines. Only then, can monetary policy levers be expected to have a meaningful impact on tempering the excesses of the investment cycle.

No. The thing that is counterintituive about macroeconomic policy is that it doesn’t matter what the money is being used for, its the amount of credit issued. If a bank loans a huge chunk of money to pay for an inefficient, broken factory or corruption, it’s not bad for macroeconomic reasons. It’s bad for other reasons, but not macroeconomics. Conversely, if a bank overissues credit to very good profitable business, this is bad from a macroeconomic perspective. Macroeconomics cares about the *amount* of credit, it doesn’t care about things like efficiency.

This is important because if you don’t have your basic macroeconomics right, then nothing else matters.  One of the basic reasons why the Russian economy died while the Chinese economy prospered was that in Russia, they destroyed the old controls without putting the new ones in place, resulting in massive hyperinflation.  In China, the old controls were gradually removed and new ones have gradually been introduced.

The thing that I find interesting is this concluding statement.

China still appears to be a long way away from a fully functioning macro system.

I find that interesting because after going through an entire essay in which he cites examples of macro-control working, he doesn’t notice the system right in front of him. China has a functioning macro system because an economy simply can’t run without one. The problem is that Mr. Roach sees the system in the United States, sees that it is missing in China, and then concludes that there is nothing there, when in fact what is the situation is that China’s macro-economic controls just work differently from the the ones in the United States.

This gets back to Deng’s dictum that it doesn’t matter if the cat is black or white as long as it catches mice. The goal of a macroeconomic control system in a market economy is to prevent boom/bust cycles and insure efficicent stable growth. Judging by the results since 1998, the system in China has been (more or less) successful at doing that. Whether this is done by interest rates or by administrative directives restricting the sale of real estate doesn’t matter much as long as it is done somehow.

Clarification on Bloomberg article

Filed under: china, finance — twofish @ 5:29 pm

The ban on IPO’s only affected Shanghai issues, and BOC’s HK issue which has been planned months to years in advance could have gone on with the Shanghai IPO. The Shanghai IPO came as somewhat of a surprise to me since it was only in late May that people started talking about it. This illustrates how fast things are moving.

June 29, 2006

The system works…..

Filed under: Uncategorized — twofish @ 4:57 pm

Supreme Court blocks trials at Guantanamo

June 28, 2006

Being grumpy….

Filed under: china — twofish @ 10:27 pm

My I’m in a grumpy mood. Francesco Sisci usually writes wonderful commentary on China, but in this case he has written an entire article which is based on false premise, that the draft law on property will change the system to give farmers individual title on land (which I’ve argued elsewhere is a bad idea since it will enable corrupt officials to use divide and conquer techniques against peasants and eliminate the actual purpose of farming which is that it is a vast social welfare program.)

The problem with this article

is that the proposed draft real property law doesn’t affect the Chinese law tenure system at all. The proposed law codifies the rules regarding property transfers and could affect privately owned law use rights, but it doesn’t change the collective system of land ownership in the villages. That is set up in Article 10 of the PRC Constitution and would require a constitutional amendment to change.

Also it does strike me as a bit naive

If the peasant has clear rights over his land, then the village chief can’t act as a middleman, pocketing huge margins between the price paid by a real-estate developer and the funds received by the peasant.

What is no doubt going to happen is that the developer, the local official, and the local judges all of whom are friends with each other are going to use semi-legal means to get the peasant to “sign on the dotted” line and hand over all his land rights to friends of the local official or else, leaving a landless peasant with nothing. There is strong reason to believe this is going to happen in rural land because it is more or less what has happened with urban land which does have a system of individual land use rights.

Under the current system, peasants can’t sign away their right to land, unless they get urban residency in which case they get social welfare benefits. Also under the current system, when land is taken out of the village pool, the whole village loses something when the land is redistributed. This creates the basis of collective action. If you have individual plots, the corrupt official is going to pick off the peasants one by one, and no one else is going to care because their land is not lost.

And Mr. Sisci really doesn’t get an the major objection to the real property law which is that it is unconstitutional. The PRC Constitution has a number of provisions which envison a system of public ownership, and the major argument against the law on real property is that it contravenes those sections, and that if the state really wants a system of private property it should amend the constitution to say so. The trouble with doing that is the with the public mood what it is, any effort to change some of the egalitarian and socialist ideals of the PRC constitution would have a huge public backlash.

There is a very curious situation in China right now, and that is that the people in the bureaucracy are the least interested in socialist ideals. I spend most of my time studying the people in the finance ministries, and I doubt that any of them more any more socialist than their counterparts in the United States. As you get further into the more “political” parts of the government (i.e. the Politburo the NPC and into the population) socialist ideals have a lot more resonance, and the people for whom socialism has the most support are the peasants and the poor.

Study in contrasts

Filed under: china — twofish @ 5:10 pm

It’s interesting to put these contrasting articles together

One in which the government is taking a more concilatory approach on rural unrest which has brought down tensions

Another where they government is still covering up an incident in which several villagers died a few months ago

One on which massive fraud has been uncovered in one bank in China

While another is getting billions of dollars in foreign investment

These are all pieces of a messy puzzle, and if you leave out any of the pieces, the picture that you get isn’t that accurate.

Here are some more pieces

1) One key part of the effort to quell rural unrest has been that the central government has started to fund local governments directly for a lot services. One reason that local governments had to resort to land sales was that this was the only way that they could raise money. One curious thing about the new system is that has to deal with public attitudes toward waste and corruption. The thing that made farmers angry was that local governments were taking their stuff (i.e. land) and using it for the benefit of local officials. I suspect that there is going to be much more tolerance of local corruption and inefficiency as long as it is funded from the central government, because the connection between the corruption and the individual is less noticable.

2) The Chinese government takes what has been called a “two handed” policy of being both “nice” and “mean.” If you are just “nice” no one is going to take you seriously. If you are just “mean” everyone ends up hating you and you lose in the end. The fact that the Chinese government uses both methods may seem paradoxical, but it really isn’t. They are just trying to stay in power, and they have enough sense to know that they can’t without being both “nice” and “mean” at the same time.

3) The Agricultural Bank of China is one of the worst banks, and the Bank of China is one of the best. One of the reasons that ABC is in such bad shape is that rural areas are economically in bad shape (Agricultural get it?). Another problem is that you can’t really shut it down since it provides banking services to lots of people in rural areas.
One thing that one has to keep in mind is scale. Several billion dollars of fraud is a bad thing, but losses due to it are not going to bring down the Chinese economy. ABC has about 600 billion US dollars in assets, and a few billion dollars lost in fraud while bad is not devastating. It’s when you start getting into the hundreds of billions of dollars (which is the Russian case) that things are bad macroeconomically.

Don’t get me wrong. I don’t think that corruption is a good thing. But there is still a difference between con-artist who cheats me out of one hundred dollars and one that cheats me out of one hundred thousand dollars. The first is bad, but its an annoyance and I’ll survive. The second could push be into bankruptcy.

Notes on proposed emergency law

Filed under: china — twofish @ 4:41 pm

Just some extra information regarding the draft law that proposes to fine Chinese media for unauthorized disclosure of emergency incidents (which is a really, really bad idea for obvious reasons).  I do disagree with the last paragraph in the Washington Post article

that reads

Some journalists expressed hope that the National People’s Congress, China’s legislature, will reject the draft law’s media provisions. In practice, however, the National People’s Congress rarely, if ever, contests government decisions.

That’s actually incorrect.  Given the amount of public outrage and annoyance within the NPC, I think it is highly unlikely that clause is going to stay in the legislation.

The draft proposal just passed first reading, but it has too more readings, and I suspect that the clause is going to be watered down or removed.  What the Washington Post article misses is that the NPC is no longer a rubber stamp legislature that takes orders from outsiders.  The membership of the NPC is largely determined by the Communist Party, but in recent years the NPC has become a forum in which different people within the party and the government argue over issues, which means that legislative drafting in the NPC actually is a real process, and not one for show.  The problem with the idea that the NPC merely does what the Party and government wants is that nowadays the Party and government often aren’t sure exactly what they want.

The fact that people actually debate and disagree in the NPC changes the dynamics of the situation.  The NPC still approves bills with near unianimous votes, but this actually works in a way that is different from Soviet-style legislatures in that any bill for which there is no consensus on passage now gets withdrawn and/or modified.  The key in the NPC (like any “real” legislature) is not the final vote, but process that gets to the final vote, and given that the clause has aroused so much screaming, I don’t see how it is going to make it through the process.

This is especially true since there is a “politically correct” reason to kill the clause.  Arguing against the clause on the basis of abstract principles of freedom of speech probably is not going to turn heads in the NPC, but arguing that it gives too much power to local officials and allows them to hide information from the center, will.  The other thing that one should note is that the proposed bill is not what the English call a “three line whip” (a oppose this and you are in trouble measure).  It’s a bill on emergency management which isn’t that high on the “pass this or else” list.

M2 and GDP – The echo chamber

Filed under: china, finance — twofish @ 7:00 am

My we do have an echo chamber in here.  It’s interesting when you see the same idea start bouncing around, and you can trace it back to the source.

There is this article by David Frum quoted by Victor Shih
which one can trace back to John Makin,pubID.24309/pub_detail.asp

China’s M2 money supply, thanks largely to heavy currency market intervention, is rising by about 17 percent annually while the economy is growing at a rate of approximately 10 percent. The Chinese claim an inflation rate of about 1 percent. There is a serious discrepancy here. With the money supply growing at 17 percent and nominal GDP (the sum of real growth and inflation) growing at 11 percent, the ratio of money to GDP must be rising at a rate of about 6 percent a year. To validate these numbers, either the demand for money in China has to be growing rapidly (unlikely) or, alternatively, the inflation plus growth numbers are way too low. If money demand is stable, that is if Chinese citizens wish to hold a fairly constant portion of their income as M2 money balances, it is true by definition that nominal growth (the sum of real growth and inflation) has to equal money growth.

The problem with that argument is that Chinese M2 growth has always been higher than nominal GDP growth since 1978, and a six percent discrepancy is actually quite a bit lower than what the difference was in the 1980’s.  The reason for this is “financial deepening” basically there are more types of assets and more things to spend your money on, so part of the growth of M2 involves the fact that money indeed is travelling through the system faster.

Some other points….

It’s hard for me to accept the argument that currency policy is generating that much liquidity in the banking system.  The PBC gets dollars which it uses to buy Treasuries and MBO’s, which means that the liquidity in the system gets tossed back at the United States.

It’s hard for me to accept the premise that the Chinese economy is not controllable, and that the PBC does not have effective tools to cool the economy, when the PBC did just that in 2004.  It took its foot off the brake a little early, but the brakes are still there.

June 26, 2006

Probably going to be at Wikimania 2006

Filed under: quantitative finance, wikipedia — twofish @ 5:52 am

Part of the reason I posted something about Wikipedia, is that I'm probably going to be at Wikimania 2006.  I'll also definitely be at the Chinese Finance Association meeting also in Boston in October, and I might stick around for the ISEAD quantitative finance conference right afterwards.

I've been noticably less shy and anonymous with my online personas since I got back from MIT a few weeks ago.  I'm not sure exactly why.   I suppose the fear that I had before was that I'd be publicly humilated at some point, and I think this is the fear that keeps a lot of people who have something useful to say from saying it.  

Why I’m spending less time posting about Taiwan on Wikipedia

Filed under: china, wikipedia — twofish @ 5:19 am

In my alternate ego (Roadrunner) I used to spend a huge amount of time posting about Taiwan on Wikipedia.  I don't do this as much and the reason might be interesting.

The reason I posted so much in the first place was to counter the strategy of Taiwan independence supporters.  As of 2003, much of their strategy was to make the idea of "Taiwan is not part of China" seem like the natural situation, and that anyone who questioned this idea was obviously delusional.  The idea behind this is that if everyone said "Taiwan is not part of China" and believed that this was the opinion of people on Taiwan, then Taiwan independence could then at some point "normalize" (their term) the situation, officially declare independence, and that would be the end of that.

You can see in this situation, where words become important.  Since I didn't (and still don't) agree to their political aims, I felt that I had to do what I could to counter their effort, and that meant posting on Wikipedia.

But the reason I don't do this any more is that this strategy has fallen apart for two reasons….

1)  Beijing became less stupid.  For this strategy to work, Taiwan independence supporters had to present a stark choice, if you didn't support Taiwan independence then obviously you must support Taiwan being part of the PRC and unification.  Since most people on Taiwan don't support immediate unification and don't think of Taiwan as part of the PRC, ergo they most support Taiwan independence.

This logic fell apart the moment Hu Jintao and Lien Chan shook hands.  At that point, "one China" no longer became synonymous with "Taiwan is part of the PRC" or "immediate unification" and the Taiwan independence logic fell apart.  Once you could articulate a political position that was neither "Taiwan is independent of China" nor "Taiwan is part of the PRC" you find that this position is pretty attractive to a many people on Taiwan.

2) Word games have their limits.  It also became obvious around mid to late-2005, that US support for Taiwan had its limits and the Chen Shui-Bian was testing those limits.  Ultimately what matters is not word games, but under what conditions the US would deploy the Seventh Fleet to save Taiwan, and the US has made it clear that US support for Taiwan is conditional on good behavior by Taiwan, and that Taiwan cannot expect to kick Beijing and expect a US bailout.  If you look at the diplomatic verbage, it became more and more obvious around 2005 and 2006, that the US State Department was becoming increasingly tired of the word games that Chen Shui-Bian was playing.

So my assessment is that Taiwan independence has lost this round, and there is no need for me to spend my time worrying much about the definition of China.  Also, it is no longer the case that anyone who disagrees with the language and assumptions of the Taiwan independence movement is considered "insane" so I'm spending less time defending my sanity.
As far as what the "China" page on Wikipedia is going to look like.  I'm going to give it a few years, but I suspect that the result will imposed from the outside.  If Ma Ying-Jeou gets elected as President in 2008, then I strongly suspect that sometime between 2008 and 2012, there is going to be some consensus statement between Beijing and Taipei over exactly what "China" means and at that point we can change the Wikipedia page to reflect that.

June 24, 2006

Got SWIG commit privileges!!!! QF update

Filed under: quantitative finance, quantlib — twofish @ 5:27 pm

I've been given commit privileges into the SWIG source tree to check in R-SWIG.  It will still take a few days before it happens.  I need to make a number of suggested fixes.  The most important of those is to get some decent unit test conditions.  The unit tests have been written, but not the test conditions.  Once that is done, the next steps are

1) Get everything working again

2) Sit down and examine the differencing in pde.hpp, I've gotten e-mail disagreeing with the difference scheme, and I need to look at it very closely

3) Write a fast fourier transform system in QuantLib

4) Add GARCH to QuantLib

Right now the three books I'm reading are Oksendal's Stochastic Differential Equations, Baaquie's Quantum Finance, and Cont's Financial Modelling with Jump Processes.  Of the three Cont is the most useful for what I'm actually trying to do, but Baaquie is a walk on the wild side, and Oksendal I'm mainly reading so that I can understand the mathematical language.

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