Twofish's Blog

April 16, 2009

Notes on economic stimulus

Filed under: china, finance — twofish @ 11:32 am

  1. Mark: And it seems unlikely that this infrastructure-intensive approach will work as well today as it did then.

    The difference is that most of the nations in East Asia are extremely developed in comparison to China, and so infrastructure intensive approaches are going to work a lot less well in a developed country than it will in a massively underdeveloped country. Infrastructure-driven development worked very, very well in East Asia in the 1960’s and 1970’s and that is the roughly the development level of China today.

    Mark: Excess capacity is more serious now than ten years ago, which means non-state sponsored investment will be harder to stimulate.

    So stimulate state sponsored investment. If the problem really is excess capacity then pay people to dynamite factories and replace them with empty fields.

    China Interest: The transition to a new growth model will not come easily – the process should have been in progress 10 years ago.

    Ten years ago, China was busy making the transition from the growth model of the 1990’s to the current one. Ten years from now, the new growth model is going to prove unsustainable, and there will be a need to transition to another one. Economies are in a state of constant transition, and one very bad economic idea is that there is this magic economic model that will guarantee prosperity for all time.

    For example, I do think that the next Chinese growth model will be very heavily infrastructure driven. It might work for China-2010 not for China-2030 or even China-2020.

    China Interest: Now I think it is too late without significant pain, and the government, from what I have observed, has yet to actually do more than lip service.

    Economic transitions are always painful and one of the consequences of constant transition is that the economy will be in constant pain. Governments will only act when the pain of doing something exceeds the pain of not doing something. Also in a growing economy, delay is good. Economic transitions are costly and if you have a growing economy, you end up with more resources to cushion the transition.

    China Interest: The government had a window of opportunity 10 years ago to take steps to improve the education system (don’t get me talking about this one, oh boy!)

    And if you look at the size of the problem, it’s amazing that they have gotten as much done as they have. If you just look at the numbers of people that need to be educate, and look at the amounts that need to be expended, we are talking about a big and tough problem that can’t and won’t be solved instantly.

    If you start looking at health and education, you very, very quickly get into issues of taxation and financing. Local governments are basically bankrupt.

    China Interest: Do the necessary reforms to include more people in the market economy, protect innovation, and give people property rights, etc… but has largely squandered them.

    No it hasn’t because a) these are huge, huge complex and messy problems and b) no one really knows what works and what doesn’t so you end up spending huge amounts of time doing experiments to see what really does work and what really doesn’t.

    I tend to mistrust people that think that problems can be magically solved quickly, because it usually means that they don’t really understand the difficulties. One is that you have a limited amount of time and attention to solve problems.

    For example, ten years ago, the government really wasn’t focused on creating an innovation economy or on health and education issues, because it was desperately trying to keep the banks from collapsing. If they banks had collapsed, then any sort of planning on health/education or creating an innovation economy would have been useless.

  2. Pettis: If he is right, we should expect US consumption (and that of many other deficit countries, for that matter) to grow less than GDP by the amount of the deleveraging taking place.Not necessarily. You can deleverage by printing money which is basically what is happening in the United States. You in debt? Well, there is several trillion dollars of freshly printed currency to cover that debt, you are now deleveraged.

    In fact the reason for printing money is so that you can deleverage without causing demand to collapse. You get inflation if you try to do this when you are near capacity limits, but that isn’t a problem right now.

    Pettis: But this was after tax cuts and government subsidies boosted demand, and there are lots of rumors about government agencies and state-owned enterprises being persuaded to anticipate vehicle purchases. If that is the case, the surge in purchases may soon peter out, and in fact may slow sharply to the extent that planned purchases for later this year were accelerated.

    They again maybe not. The whole point of stimulus is to get money flowing. Once you have money flowing then the SOE will have the cash to buy an extra car at the end of the year, which gives cash to the car manufacturers. Plans can change.

    Pettis: The second group of positive indicators I would describe not as evidence that the fiscal stimulus is working but rather as evidence that some people are behaving as if they believe the fiscal stimulus will work.

    Again, if people think that it’s working, then it is working. One other purpose of fiscal stimulus is to change psychology so that people will spend more, so if people think that the stimulus is working and are willing to spend more, then the stimulus is working.

    Pettis: Perhaps they are right, in which case we should see more positive indicators in the future, but if they are wrong then we are likely to see nothing more than a temporary buildup that will have to be reversed.

    This reverses cause and effect. People’s attitudes affect the economy more than the economy affects people’s attitudes. If people think that the economy is going to improve (and there is idle capacity) then the economy will improve. When you have a situation of overcapacity and under-demand, then the limiting factor in economic growth is psychology, so change the psychology.

    Also looking at Minsky’s theory of the business cycle, you tend to have positive feedback. People think the economy will improve -> the economy improves -> people think the economy will improve even more -> the economy improves, and before you know it, you are in a situation where people have totally unrealistic expectations of the future, and which point things blow up and the process unwinds very quickly. If all goes well, then we should have another crash around 2020, at which point we will all be back to the drawing board trying to destroy the economic model that we created in 2010.

    One funny observation that someone has made is that before 1978, China didn’t suffer from any financial crises, but since 1978, China has gone from one financial crisis to the next one in rapid succession. Similarly since World War II, South Korea has also been having constant financial crises whereas North Korea has been free of financial crises.

April 5, 2009

Notes on Chinese banking

Filed under: china, finance — twofish @ 6:27 am

Rajesh: The data shows that most of the Chinese savings rate does not come from individuals, the savings occurs in businesses and state owned enterprises.

The current savings rate is 50% households and 50% SOE’s. The amount of household savings has remained constant for the last 30 years, but what happened after 2000 was that you had this burst of SOE savings.

Looking back it now appears that the Chinese banking reforms of the late 1990’s was one of the most successful examples of basic financial restructuring, and it’s something that the US should try to learn from. (And China modeled a lot of the reforms on the US savings loan fix in the 1980’s.)

Rajesh: Now for most small businesses, it is academic whether the savings are attributed to the business or its owner but for the larger enterprises it implies that those funds can not easily be diverted to consumption; they are more likely invested in new plant and equipment.

It’s not that hard. The government can take a dividend and invest in health and education. There are two problems 1) is political which is that the SOE’s don’t want the government to take their money and 2) you need to set things up so that the incentives are right. If the government takes SOE money any time they make a profit then there isn’t much point in making a profit.

Rajesh: Also most of the larger companies, because they have large profit margins, are self-financing and less dependent on banks for loans (which explains why the economy did not slow down as the central authorities raised interest rates and reserve requirements.)

I think that isn’t the big explanation. The government can just order the big companies not to spend money. They are state owned after all, and the government has control over their capital budgets.

The big explanation for why it was hard to cool the Chinese economy I think was that large sectors of the Chinese economy (like exports and construction) were big financed by Western banks. One of the ironies is that the economic downturn hasn’t hit Chinese banks which whose lending to construction was limited, but it has hit Western banks hard.

It’s ironic because for about a decade, Western banks and economists were lecturing Chinese banks on the need to improve risk management and avoid NPL’s, and Chinese banks took those lectures seriously. Western banks didn’t.

Rajesh: Peasants in China for the most part do not have bank accounts. Much of the rural economy is on a cash or barter basis.

This isn’t true, most peasants do have bank accounts. Rural China has a pretty extensive banking network in the form of rural credit cooperatives. A lot of this comes from China’s socialist past. Because the major banks are state-owned, having a bank in a small village is like having a police station or a post office. It’s a sign of state authority (and Japan has a huge postal savings bank).

Most of these rural banks are totally insolvent, but they are there. The fact that rural Chinese are tied into the financial system is what makes China very different from Latin America.

There is a huge problem with rural banks, but it is on the lending side and not on the deposit side. The problem is that because the rural banks are broke, they aren’t lending to rural areas, which is one reason why urban areas are developing so much faster than rural areas.

It’s also why Western banks never got very far in commercial banking. The idea that Western banks had was that they would be so much more efficient, that people would abandon Chinese banks for Western banks. It turns out that at the retail level, people don’t care how efficient your bank is. The care that they have an office around the corner.

April 3, 2009

Ooppss. Western banks and Chinese real estate

Filed under: china, finance — twofish @ 2:29 am

This article illustrates a piece of the puzzle, i.e. who was pumping money into the Chinese real estate market in the boom years.  It turns out that it was a lot of Western banks and private equity firms that are now facing huge losses.

One thing that the article didn’t mention is *why* Chinese real estate companies went to Western banks for funding, and it was because the Chinese government wouldn’t let Chinese banks touch the stuff, largely because the government had just bailed the Chinese banks out once before and weren’t about to do it again.

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