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.

http://www.morganstanley.com/GEFdata/digests/20060630-fri.html

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,

http://www.pbc.gov.cn/detail.asp?col=100&ID=1819

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.

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