Saturday, January 30, 2010


Asian stock markets finished January in a falling streak worst since last March. This is partly due to US rebound and rising dollar, but also fundamental disbelief in China's hard to believe economy that claims to be overtaking the size of Japan to become World #2 - is it an economy bubbling fit to burst? There is reason to believe China's economy is only half the size it claims, no bigger than say California or Italy?
The waning investor appetite since equities hit 15-month peaks 10 days ago is most obvious in Asia-Pacific stock markets. Jitters about the impact of monetary tightening in China that expose then burst its own fragilities never mind the fragile global economy is debated from New York to Tokyo and reflected in investment bank notes.
A report from Reuters shows mutual funds in China share those concerns.‘Risk Aversion Trade’ (RAT) that feasts off sovereign debt woes, e.g. Greece or Ireland; the approaching unwinding of stimuli (government exiting the banks) in the US, UK and EU; plus concern that financial assets remain badly priced, again overpriced, and growing if reluctant respect for good-old-fashioned economic analysis, encourage bubble-talk such as is Chinese property running of a cliff and maybe a year or two down the track is EU still heading for its real recession? China's fund managers appear to be cutting real estate stock weightings by a third.
The dollar’s days as the symbol of risk aversion are over. Yesterday it rallied to a 6-month high. The Anglo-Saxon economies are determined to deliver positive news e.g. UK out of recession and US fourth-quarter GDP rising faster-than-predicted 5.7 per cent, which in its wake will pull UK out of its morass. Volatility continues however as trader jockey to keep their jobs and focus on shorter-run profit plays.
Let's look at China's GDP - is it believable?
The economic success of China dominates its image in the world. Stats reports are perceived to be critically important, major (even dominant) factors in maintaining growth. But, official statistics about China’s economy do not make sense for many reasons. It is realistic to place more confidence in India’s official statistics. It is compelling to conclude that China’s statistics are political window-dressing – propaganda- driven to maintain an image that is deemed vital to its continued growth, but resulting in the economy being measured to be approximately twice its actual size.
When average wages are about $200 per month per person in labour force (800+ million labour force and probably really only 90% in work) while national income is $300 per month per capita (for whole 1300 million population)! The misalignment is not explained by trade surplus, net foreign investment inflow (inflow worth $50 per worker per month, $20 net) – but by over 40% of GDP explained as annual new infrastructure investment (fixed capital investment i.e. construction & machinery investment in a ratio of 1 to 4, without depreciation calculations) that is $150 per worker per month. Household spending is $180 per worker, or 35% ratio to GDP compared to 70% in developed economies. The likelihood is that assets growth values of fixed capital investment between project start and finish are being somehow included in GDP!
In 1985 to 2000 fixed capital investment was 30-36% ratio to GDP, half a high again as ever was in Japan (peaking in a construction and property bubble that burst in 1990) or Germany except in immediate post-war years. When the property bubble bursts in China its economy will deflate greatly and the banks all become technically busted as happened in the 90s! Chinese GDP components, which might look reasonable at first blush. But, subtracting investment, net exports, and government spending from GDP, we arrive at sum of consumption spending plus inventory investment, represented by a steeply falling curve than dived in ‘05, even if officially not shown until '07, and can't remotely be explained by inventories. The implausible behaviour is clearer when plotted as growth rates. In '05 for example citizens spent 17% less on daily necessities and luxuries than the previous year, but not what other official statistics say - that retail spending for the year was 14% higher than the previous year, alone double the remainder calculated for all personal consumer spending.
It is impossible to calculate China’s true GDP without independent access to growth statistics across the entire country. All regions report higher growth when that is most unlikely. In OECD countries growth is never evenly spread and they have policies to transfer income from rich to poor regions that China lacks. In OECD countries it takes 2 years of hindsight to make GDP figures accurate. In 2002, I recall the senior economist for HSBC writing: "We suspect that certain local officials may have seriously overstated fixed-asset investment in their areas to boost their political credibility. Analysts can still reach useful conclusions by focusing on trends rather than exact amounts in the official figures. Sometimes, however, the problem can exceed itself.”
Energy consumption and other physical indicators do not support the reported growth of national income and some countries dispute the trade data. Note: GNP is essentially wages + net profits + trade balance, also explained separately as consumption spending + savings + new investment. If the two sides do not add up as they should – is the balance achieved by inflating capital investment as a residual estimate? It is impossible to maintain Chinese wages at low levels to compete with India and other much poorer Asian economies and at the same time expect to become the world’s second largest national economy, to seek a status as globally wealthy when the people remain domestically poor?
Bank loans have grown by 15% and then last year 30% with a fiscal stimulus to force growth but when inflation has been reported for years as very low or negative, including currently negative, despite years of 20-35% money supply growth. In much of 2009, 2% consumer price deflation and 6% producer prices deflation – to push excess output into exports to a now unwilling importing world i.e. via massively subsidized exports. Bank lending (business debts and redit supported property asset values) must now be unserviceable by borrowers – unsustainable and heading for collapse, hence the recent decision to radically rein in lending by a third, which will not put the cat back in the bag, but trigger borrower defaults sooner than later! The State Statistical Bureau takes only 15 days to survey the economic progress of 1.3 billion people. Revisions are a farce: No growth figure was ever been revised down, and upward revisions are incomplete to the point of uselessness. At best, earlier activity is measured; at worst, results are manufactured to suit the propaganda. The aim is to be able to announce that the economy has overtaken the size of Japan’s economy (when in reality it is probably not yet bigger than France, Italy or California) or about 4-5 times the size of the USA trade deficit.
In mid-2009 the main engine for growth, again, was fixed investment, rising by one-third or twice the speed of retail sales, and equivalent to a staggering 65% ratio to GDP, an unprecedented figure for an economy that is supposed to have a significant market element and a figure that cannot be reconciled with a transition to the market. Either investment recedes or the market does.
For China’s economy to be producing $4.9 trillion and growing at 9%, China must be an economy worth 25 Hong Kongs and building equivalent of two new complete Hong Kongs every year. HK’s population is 0.5% of China’s but HK has 12 times higher average incomes – just under the level of Japan and USA. Japan’s exports are $5,500 per capita, HK’s $25,000 and China’s $1,000 (or 62% of all employment wages, which is a measure of how exposed the economy is to trade – worth 25% ratio to GDP!)
India’s data is more convincing. Exports are high at 14% ratio to GDP (proportionately twice that of USA, which has high imports at 10% ratio to GDP).
Beijing's response to the crisis is to intensify pre-crisis policies instead of recognizing that it must restructure the economy – change its business model – to deepen and broaden the economy internally and relay far less on trade and export-dependent capital investment and allow wages to rise, enforce 40 hour week and encourage domestic consumer spending, even to the extent of several years, perhaps 1-2 decades falling trade surplus turning into trade deficits, which its currency reserves can well afford. The damage caused by a global demand bubble inflated by overly loose American money has been talked up by the media as something to be healed by help of Chinese production and asset bubbles inflated by overly loose Chinese money. Brookings Institute in USA went further to look forward positively to the OECD world being dragged into higher growth by poor countries (Third World as was) falling into large trade deficits to be paid for by increases in ‘western’ aid.
But China appears to have decided to put off restructuring into some indefinite future when the external situation is better, whatever that means? Of course, at that ‘better’ time, the economy will appear yet again to be firing on all cylinders (except workers’ wages) and reform will--again--be dismissed/postponed. This is the same mentality that led the banks into the credit crunch.
Keeping one's eyes pinned to current GDP growth shows an improving Chinese economy. A realistic view shows a credit boom economy (but not for the mass of the citizenry) that is unsustainable, trying to drag itself and the rest of the world back along the trail that led to the current economic crisis and heading for a steep fall into a hole of its own digging.

Wednesday, January 20, 2010


(photo shows a BoE Beadle wearing the knew lightweight uniforms to replace the older heavy serge quality uniform - they, by the way, hate the new cheap style and want to return to the old uniforms, heavy and warm - BoE fashion advisor take note).
Bank of England Governor Mervyn King gave a speech at Essex University (his first since last October - a silence many assumed was because he was snowed in by complex calculations). The speech was 'meadia spun' by the BBC to suggest its focus was a severe criticism of government policy, and of No.10 more than No.11 Downing Street - an example of trying to eke a political story out of an economic one, a speech that was subtle, complex and a tour d'horizon of certain matters treated skillfully, subtly, perhaps too subtly for the broadcaster?
A clinically sober reading of the speech sees facts about the economic system's way of working described without implied political criticisms. Yet, BBC Radio 4 and BBC news web-site dramatically spun Mervyn King's speech(20 Jan) to read between the lines what was not there i.e. criticism of Government.
Full Speech:
The journalistic spin is summed up by "Mr King's remarks may have been aimed as much at number 10 Downing Street, as number 11" and in a pre-election climate there are those who would love to read the bank of England as favouring a change of government?
See last para.
The journalist's implied view is that King was saying a higher savings rate is hindered by the government's deficit. But, to a trained economist, that makes no sense. Savings always rises and falls in exact proportion to GDP as government deficit rises and falls; they are national income accounting counterparts!
The quote "a key element in raising the national saving rate is the elimination over time of the structural deficit in the public finances". This states what is a factor, not what direction it is working in. UK savings rise as an exact counterpart of government deficit has been rising for many months in the same period as the budget deficit, and since Sept.08 to Nov. 09 (last published data), all UK sterling savings rose 10% and bank deposits by 50%. See Table B1.2
The quote, "But uncertainty about how and when fiscal policy will respond has a direct bearing on monetary policy. And markets can be unforgiving" is also cited loosely without direct comment or explanation, leaving it like a hanging chard as if implying political criticism. But as everyone should know uncertainty in monetary and to a lesser extent fiscal policy in their details are normal and necessary.
All that King wanted by saying this was to emphasise importance of statements adverting 'fiscal sustainability' - why, because he said markets gyrate around preliminary data yet to be much revised in hindsight, for which we can read spin to exploit unreliable data, and to say that new data in the next few months will be very much like that, but not to worry. He ends by saying what all empirical economists know that data remains unreliable for 2 years, which must have been his main point in the speech.
The first news about the speech on Radio4 was that King had said something like recovery would be hard and take maybe a decade - that seems later to have been dropped because it was not in the speech.
When King referred many times to 'saving' mainly about 'high-saving' countries he meant trade surplus countries and 'low saving' trade deficit countries. Most of the speech was about world trade imbalances - all of which the BBC ignored in favour of one reference to saving in UK, by which he mainly meant the need to reduce the UK trade deficit, and if there is an implicit message it is that in regard to 'national savings rate' and not household savings per se directly. Therefore if there is political criticism at all implied, it is to structure the fiscal impulse and to time the deficit reduction with respect to the economy's external account!
The key policy phrase in King's speech is actually, "Looking ahead, monetary and fiscal policy together must help to bring about a switch of demand from private and public consumption to net exports and business investment as the recovery takes hold."
There is a real credit crunch story here, which is that this is a repeat example of what the central Banks were saying, if too subtly, almost quarterly in recent years to all banks in credit boom economies, to very sensibly advise them to shift their lending away from mortgages, finance, and consumer loans, to industrial sectors whose borrowing from banks remained static or falling for a decade, as did Government's borrowing and debt, while mortgages, financial services and general private debt tripled causing the asset bubble. Banks ignored the message, not seeing in it an order to rebalance their loan books to care for economic sustainability. For your information, to take one example, lending to all small businesses in UK (half of private sector jobs) is only 5% ratio to GDP when all domestic economy lending by banks is roughly 40 times bigger!

Saturday, January 2, 2010

Stiglitz's Six Lessons?

There have been times when white bearded Nobel prize-winning economist Joseph Stiglitz has taken on the mantle of Father Christmas in expressing a positive view such as over what should be done by World Bank for poor countries, and again now in respect of summing up where we have got to in learning from the Credit Crunch and the global recession it triggered.
In the China Daily, Joe Stiglitz summarised his view, “The best that can be said for 2009 is that it could have been worse, that we pulled back from the precipice on which we seemed to be perched in late 2008, and that 2010 will almost surely be better for most countries around the world. The world has also learned some valuable lessons, though at great cost both to current and future prosperity – costs that were unnecessarily high given that we should already have learned them.”
It would be a comfort to know that the world learns from mistakes - not so, in my view; the world so-called merely adapts to whatever the compelling circumstances of the time and place are and will otherwise repeat whatever is self-serving. Just as warnings of the crash ahead of time by the BIS, a few other central bankers and a handful of economists, and others here and there, these were discounted or lost in the noise in the trading rooms etc. Learning lessons requires playing politics and it remains a struggle to get the hard lessons accepted and then harder again to get these translated efficiently into succinct actions; there is no shortgae of resistence and red herring distractions, the 'blame game' is still being played.
"Better for most countries" is a debateable forecast given that there remains much unravelling, ever-yet widening ripples and aftershocks - businesses closing down and unemployment high or rising (except UK). Many countries, perhaps most, have gaping uncertainties about their external account and therefore of their growth prospects if any?
Brookings Institute recommended in a report late last year as a positive outcome that we could look forward to a massive trade deficit this year and next by emerging countries, sufficient to further narrow the trade deficit of the USA, and thereby replace it to help pull the rest of the world via export-led growth, what China, japan and Germany especially rely upon, however irresponsibly that is i.e. pull the rich world into better growth by improving its trade balances - a most unseemly paradox that the poor should, by getting deeper into debt, help smoothe the prospects for the rich, who will then finance that via more aid to poor countries!
But, anyway, what are the six so-called “harsh” lessons, according to Stiglitz?
1. Markets are not self-correcting, and without adequate regulation, they are prone to excess. We could just as easily say markets are prone to Bilateral vestibulopathy - a condition involving loss of inner ear on one or both sides that causes giddy, woozy, false sensations of movement, spinning, or floating i.e. unbalancing themselves or indulging in fashionable gyrations among different sectors.
Markets have what call a 'camera shake' that is roughly 1.5% price moves either way, up or down, whereby individual stocks have a 3% average price vibration daily given that market indexes are the aggregate of gains and losses. This fact is how dealers can make money by zero or minimum thought and by being in the thick of what is just inter-day and intra-day spreads & shakes - the more you leverage the more you make, that is until several days in a row go in the wrong direction. Regulation has yet to find a way to enforce quality and more stability; regulatory rules are more about accommodating losses and avoiding systemic risk, however forlorn that may be - and not about mintaining some securely safe balance in behaviour. Markets are self-correcting by their vibrations, but not within the limits that would leave government out of the recovery equation when recession strikes.
2. There are many reasons for market failures. Too-big-to-fail financial institutions had perverse incentives: Privatized gains, socialized losses. This is pandering somewhat to popular anger. There are also massive privatised losses and there will be socialised profits from government support of the banks - stepping into replace private finance in funding banks' funding gaps. Self-correction is a matter of boundaries and timeframes, but self-correct they do, just not as painlessly as would be politically tolerable.
3. When information is imperfect, markets often do not work well – and information imperfections are central in finance. This is a non-sequitur; perfect information would also be disasterous. It would be more sensible to say markets work best when information is less than perfect but not so imperfect that they behave suicidally, or some equally asinine further insight into the bleeding obvious.
4. Keynesian policies do work. Countries, like Australia, that implemented large, well-designed stimulus programs early emerged from the crisis faster. The US, UK and others have implemented what can be classed as Keynesian if by that is merely meant higher deficit spending adjusted to whatever will propel economies back to a path of net new job creation. Emerging from the crisis, faster or slower cannot be fairly judged simply. The Eurozone, for example, had a sudden deep recession and then regained positive ground, but is likely to face its 'normal recession' in 2011 and 2012 if it follows normal lagged response to US recession. The UK recession may have just ended, but in world terms of US$ terms its economy has shrunk to a level going forward far below what is reflected merely in the economic cycle measured in domestic currency. China may look invilate but its official data is subject to shameless positive spinning and it cannot continue to rely on export led growth as before - it is not an energy exporter and has not yet learned how to rely on its domestic demand. Keynesianism that Stiglitz refers to is at local level - country-specific - when in our 'globalized world' we need to gauge Keynesianism in world economy terms and few are thinking in those terms beyond G20 meetings and UN or IMF research papers.
5. There is more to monetary policy than just fighting inflation. Excessive focus on inflation meant that some central banks ignored what was happening to their financial markets. The costs of mild inflation are miniscule compared to the costs imposed on economies when central banks allow asset bubbles to grow unchecked. Central banks actually worry about much more than inflation; they worry about the stability and integrity of their national or currency zone financial markets i.e. about banks, currency rates, external obligations and government bonds. It was hard for them to address the property bubble when there were many rationalisations justifying tolerance of fast rising property values, which let us not forget was a boon to emerging markets trade balances and debts as well as underpinning so much of bank debt and solvency in OECD countries. It is the residual high value of property assets and low mortgage defaults in Europe that are furnishing a floor or basis for banking recovery. Moreover, central banks and many others would accept that asset bubbles are an inevitable part of economic cycles that in turn are inevitable, even desirable. Therefore, the concern is about not letting asset bubbles become excessive like the famous Dutch tulip mania of John Law's Mississippi Scheme or Scotland's Darien Adventure and the many bubbles since then - but this would require giving central banks a power that many would call despotic and politically or democtraticaly intolerable? Stiglitz wants a Keynesian less Monetarist, less inflation-obsessed economic policy thinking - fine, but lessons will no be leatned or new thinking instituted without a new macro-economic theory and who is coming up with that - no-one that I can see getting that out to become the new othodoxy. Keynesianism is certainly helpful, but today we need a new Keynes - where is he, or she? A new theory however developed out of reconstituting past theory and lessons learned will also need a new central conception of economic growth, one less based on micro-economic analogy such as Adam Smith's pin factory and one based more on economic systems such as the economy of cities and far more global in scope. My advice is to look at economists such as Francis Cripps and Wynne Godley and their adherents, at UN models and at macro-economic policy models, which in future will need to have fully-interconnected macro-financial models. Even then, what happens if all we get is a cynical knowing perfect information outlook about the world's macro-economy. The Credit Crunch may have been disarming and impoverishing for those, many of whom who had much to lose, but has been a boon to others, not least a major transfer of wealth and income from rich to poor countries - suely a great thing?
6. Not all innovation leads to a more efficient and productive economy – let alone a better society. Private incentives matter, and if they are not properly aligned, the result can be excessive risk taking, excessively shortsighted behavior, and distorted innovation. Again, twas ever thus, and why should it ever be otherwise. I admire Stiglitz for having a go, but cannot see how his six points are lessons we have learned or should learn, and it disheartens me when great economists slip into journalistic statements that cannot stand rigorous examination. Would our economics graduates have come up with anything less and would they not have been sent back to the drawing board by any viv committee if these 6 points were the sum net total of their theses?
Stiglitz has elsewhere estimated the cost of the war in Iraq and Afghanistant to the US budget or economy as over a number of years costing about $3 trillions, which is on the same scale (or more) than the government finance gross investment-cost of Credit Crunch bailout and banking recovery (see Vanity Fair, April 2008). Given that Credit crunch and wars are coinciding surely we cannot learn economy lessons from the one and not the other, and from whatever other major singularities that can be pointed to and given a mult-$trillion price-tag or butcher's bill?