Wednesday, June 29, 2011

Today's links

1--Overworked America: 12 Charts that Will Make Your Blood Boil, Mother Jones

Excerpt: Productivity has surged, but income and wages have stagnated for most Americans. If the median household income had kept pace with the economy since 1970, it would now be nearly $92,000, not $50,000.....(great charts)

2--Shilling: Why China’s Heading for a Hard Landing, Bloomberg

Excerpt: China is much more vulnerable to an international slowdown than is generally understood. In late 2007, my firm’s research found that too few people in China had the discretionary spending capability to support its economy domestically. Our analysis showed that it took a per-capita gross domestic product of about $5,000 to have meaningful discretionary spending power in China.

About 110 million Chinese had that much or more, but they constituted only 8 percent of the population and accounted for just 35 percent of GDP in 2009, while exports accounted for 27 percent. Even China’s middle and upper classes had only 6 percent of Americans’ purchasing power.

Why Overconfidence Abounds

With such limited domestic spending, why do so many analysts predict that China can continue its robust growth?

In part because they believe in the misguided concept of global decoupling -- the idea that even if the U.S. economy suffers a setback, the rest of the world, especially developing countries such as China and India, will continue to flourish. Recently -- after China’s huge $586 billion stimulus program in 2009; massive imports of industrial materials such as iron ore and copper; booms in construction of cement, steel and power plants, and other industrial capacity; and a pickup in economic growth -- the decoupling argument has been back in vogue.

This concept is flawed for a simple reason: Almost all developing countries depend on exports for growth, a point underscored by their persistent trade surpluses and the huge size of Asian exports relative to GDP. Further, the majority of exports by Asian countries go directly or indirectly to the U.S. We saw the effects of this starting in 2008: As U.S. consumers retrenched and global recession reigned, China and most other developing Asian countries suffered keenly....

Overconfidence in China’s ability to keep its economy booming is also partly psychological. It reminds me of the admiration and envy (even fear) that many felt toward Japan during its bubble days in the 1980s. As Japanese companies bought California’s Pebble Beach, Iowa farmland and Rockefeller Center in New York, what was safe from their zillions? Then the Japanese stock and real-estate bubbles collapsed, and Japan entered the deflationary depression in which it’s still mired....

They were enjoying a well-oiled growth machine. Growing exports, especially to American consumers, stimulated the capital spending needed to produce yet more exports and jobs for the millions of Chinese streaming from farms to cities. Wages remained low, due to ample labor supplies, and held down consumer spending. So did the high Chinese consumer saving rate. Because Chinese could not invest offshore, much of that saving went into state banks at low interest rates. The money was then lent to the many inefficient government-owned enterprises at subsidized rates.

In a country where stability is almost worshipped, why would any leader want to disrupt such a smoothly running economy?

3--"The Strategic Petroleum Reserve Drawdown", Economist's View

Jim Hamilton analyzes the effects of the International Energy Agency's plans to release 60 million barrels of oil from the strategic reserves held by 28 member countries (the US will contribute about half of this total). I think it would be fair to say he's not impressed with this plan:

The Strategic Petroleum Reserve drawdown, econbrowser

I share his assessment:

...the deed is now done, and the IEA has run an interesting experiment for us in how oil markets function. I would recommend against further SPR sales, regardless of the final outcome of the current effort. The reason is that I see the long-run challenge of meeting the growing demand from the emerging economies as very daunting, and in my mind is the number one reason we're talking about an oil price above $100/barrel in the first place.

A one-time release from the SPR, or even a series of releases until the SPR runs dry, does nothing whatever to address those basic challenges.

It's not clear how much impact this will have on prices, but if prices do drop as a result of the release, some countries may take advantage of the opportunity:

the Chinese might see a temporary drop in prices as an opportunity to add to their own SPR. To the extent that happens, we're getting back to the no-effect scenario

If we had a Strategic Job Reserve to draw upon, or something similar, e.g. an infrastructure bank, that might make a difference. But I don't think this will do much to help.

4--Shilling: China Heading for a Hard Landing, Pt. 2, Bloomberg

Excerpt: And a tightly controlled economy can get results quickly. That’s what happened with China’s $586 billion stimulus program introduced in 2009. Growth in gross domestic product leaped from a 6 percent rate in early 2009 back to double digits. Most of the money was channeled through government-controlled banks, whose lending increased by $1.4 trillion, or 32 percent, over the course of 2009 after being flat since early 2006. The money supply increased by 29 percent.

Those loans financed public and industrial infrastructure and real estate. Property prices in January 2010 were up 9.5 percent from a year earlier, according to government numbers, and much more by private realistic estimates. Employment gained along with economic activity, and in the third quarter of 2009, there were 94 job openings for every 100 applicants, up from 85 in depressed 2008, and close to the pre-crisis average of 97....

China’s reliance on exports and a controlled currency for growth, for instance, will no longer work if U.S. consumers are engaged in a chronic saving spree, as I believe they will be. Chinese export growth, which averaged 21 percent per year in the last decade, is bound to suffer.

Unsustainable Growth

Here’s what we should remember: This kind of growth is unsustainable, and it won’t be able to cover up China’s underlying vulnerabilities forever....

less saving and more Chinese consumption won’t substitute for weakening exports any time soon. Chinese consumers buy only about one-tenth of those in Europe and the U.S. combined. As the euro zone remains troubled, and the U.K. slashes government stimulus and U.S. consumers continue to retrench, it’s unlikely that a drop in Chinese saving could offset the negative effects of reduced exports....

Inflation Looming

Finally, China’s state-controlled economic boom may soon lead to crippling inflation. In February 2010, the director of the National Bureau of Statistics said that “asset-price increases pose a challenge for macroeconomic policy.”

The housing boom has pushed up prices to the point that apartments in Beijing are affordable to only the top 20 percent of earners -- they’re selling at about 22 times average income (average U.S. house prices peaked at six times average income). A square meter of property in China costs an estimated 164 times per-capita income, compared with 33 times in high-priced Japan.

The 2009 stimulus package also spurred consumer price inflation to a year-over-year acceleration of 5.5 percent in May. Food prices are very sensitive politically because so many Chinese are at subsistence incomes, and they rose 11.7 percent in May from a year earlier.

5--The Shadow Banking Problem in China, Credit Writedowns

Excerpt: Despite Chinese government's efforts to rein in liquidity by hiking rates and raising the reserve limit to an unprecedented 21%, the consumer inflation index has risen 5.5% over the past year. That level is a three years high, according to figures released by Chinese government on Tuesday.

In China, the persistence of inflation pressure has brought “shadow banking” into a topic of hot debate recently. According to a study issued by the People's Bank of China in 2010, non-banking sector lending has expanded to 63.3 trillion Yuan, ($10 trillion), 44.4% of total lending activities of China's economy.

Shadow banking, a concept coined by the US Federal Reserve, refers to non-banking financial institutions with some banking functions, but they are not or less regulated like a bank. In the U.S., the lack of regulation for the securitization of traditional financial products, including home loans, was one of the major causes of the financial crisis.

Shadow banking in China mainly exists in the form of "Bank and Trust Cooperation", the underground financing networks; but small loan companies and pawn shops also play a role in these shadow financing activities.

While mortgage securitization is not an issue in China, the “Bank and Trust Cooperation” is a vehicle to provide 'hidden' loans to enterprises outside the scope of the bank's reserve limit. Similar to the credit securitization problems in the US, the banks play the role as an intermediary. They charge service fees and commissions for services provided, while referring the securitized loans to banks customers, and raising funds off the bank's balance sheet.

Data released on March 31th, by China Trustee Association, shows that the scale of Bank and Trust Cooperation as has already reached to 15.3 trillion yuan ($2.35 trillion). The risks of such financial arrangements are asymmetrically transferred to buyers. Since no credit ratings are available for these debts, the buyers have to blindly follow the bank's referrals, hoping the banks, which make money from commissions and fees no matter what happens with the loan, have done due diligence and are honest.

Fortunately, unlike the mortgage backed securities that traumatized the US economy, the assets of China's “Bank and Trust Cooperations” are yet to enter the stage of complex financial leverage. Also last January, the CBRC ordered commercial banks to incorporate this type of lending into their balance sheets by the end of this year....

Since, in many places, underground banking generally promise at least 5 times higher returns than legal banks, market forces allow the underground banking to flourish.

Shadow banking in China will continue to grow as long as commercial bank lending is unable to meet liquidity demand and interest expectation. However the scale of shadowing banking is undermining the effectiveness of monetary tools to combat inflation. Since last October, China's central bank has raised reserve requirement ratio nine times already, but the inflation pressure still remain high.

Early in May, the Chairman of the China Banking Regulatory Commission, Mr. Liu Ming Kang spoke out at the 22nd committee meeting, claiming that one of the major risks the banking system faces is 'shadow banking'. This is the first time that the CBRC has raised the red flag. Such a statement indicates the increasing uneasiness the regulatory body is having, while trying to engineer a soft-landing.

6--Warnings from the central bankers’ bank, Nick Beams, WSWS

Excerpt: The rot and decay at the heart of the global financial system is deepening and extending. This is the conclusion to emerge from the annual report of the Bank for International Settlements (BIS) released on Sunday.

The BIS, sometimes referred to as the central bankers’ bank, was one of the few institutions that pointed to the dangerous imbalances in the global financial system that led to the collapse of Lehman Brothers in September 2008. Three years on its annual report gives clear indications that another financial crisis is in the making.

One of the biggest dangers comes from the massive assistance provided by central banks to the banks and financial institutions through ultra-low interest rates and interventions into debt markets. The third consecutive year of “extremely accommodative financial conditions” coupled with “near zero interest rates in the core advanced economies increasingly risk a reprise of the distortions they were originally designed to combat.”

The extent of this intervention is indicated by the growth of central banks’ balance sheets to “an unprecedented size.” In response to the financial crisis, the US Federal Reserve and the Bank of England have both increased their assets from 8 percent of gross domestic product (GDP) to around 20 percent, while the increase in the Eurosystem is from 13 percent to more than 20 percent of euro area GDP....

The BIS has called on governments to take “swift and credible action” to bring down debt levels. But this does not mean a return to the pre-crisis situation. So-called “structural tasks” have to be addressed. “In many countries ... [this] involves facing up to the fact that, with their populations ageing, promised pension schemes and social benefits are simply too costly to sustain.”

That is, large portions of the social welfare measures enacted in the post-war period must be wiped out to pay off the government debts incurred as a result of the bailout of the banks. The BIS insists that a return to the “pre-crisis fiscal stance will not be enough” for at least two reasons. Pre-crisis fiscal positions looked “too rosy” because of the tax revenues from asset price booms; and surpluses must be built up to act “as buffers that can be used for stabilisation in the future.” In other words, the working class must be made to pay not only for the past crises created by the banks but for future ones as well....

7--Going Swedish, The Big Picture

Excerpt: The Washington Post discussed this truism last week in an article titled Five economic lessons from Sweden, the rock star of the recovery.

What were those five lessons?

1. Keep your fiscal house in order when times are good, so you will have more room to maneuver when things are bad.

Prior to the 2008-09 recession, the U.S.and Britain had budgets deficit equal to 3% of GDP. Sweden had a 3.6% surplus. Sweden’s gross debt is ~45% of its economy; the US is nearly 100%. This left the government with lots of flexibility to engage deficit spend when the economy hit a crisis.

2. Fiscal stimulus can be more effective when it is automatic.

Sweden’s response to the crisis was provide income, health care and other services to people who are unemployed. That prevented a paradox of thrift from making a minor redcession something much worse.

Their spending programs cushioned economic blows, and can be designed to taper off when the economy turns.

3. Use monetary policy aggressively

As aggressively as the Federal Reserve has responded to the financial crisis, the Swedish central bank was even more aggressive. The Riksbank lowered its target short-term interest rate nearly to zero, but it expanded the size of its balance sheet even more than the Fed did relative to the size of its economy. In the summer 2009, the Riksbank balance sheet was more than 25% of GDP. The Fed, never got over 15%. And, Sweden was much faster to normalize their footing versus the Fed, who is still zero bound. Swedish central bank have already raised rates.

4. Keep the value of your currency flexible.

The Swedish krona was a helpful buffer against the economic downdraft of the past few years. It fell in value against both the dollar and the euro during the crisis, making Swedish exporters more competitive.

5. Bankers will always make blunders; just make sure they don’t doom the economy.

Swedish banks made mistakes, just like the rest of the world. But their losses were more manageable. And due to their crisis in the 1990s, where Sweden’s major banks were temporarily nationalized, Bankers were not cushioned from the consequences of their unwise decisions. They did not learn the ruinous lesson of privatized profits and socialized losses that US Bankers have turned into a motto.

8--FRBKC Pres Hoenig: “Big Banks Put Capitalism at Risk”, The Big Picture

Excerpt: Hoenig’s concern is not for the welfare of any specific bank or even the banking system, but rather for the entire capitalist system itself:

“How can one firm of relatively small global significance merit a government bailout? How can a single investment bank on Wall Street bring the world to the brink of financial collapse? How can a single insurance company require billions of dollars of public funds to stay solvent and yet continue to operate as a private institution? How can a relatively small country such as Greece hold Europe financially hostage? These are the questions for which I have found no satisfactory answers. That’s because there are none. It is not acceptable to say that these events occurred because they involved systemically important financial institutions.

Because there are no satisfactory answers to these questions, I suggest that the problem with SIFIs is they are fundamentally inconsistent with capitalism. They are inherently destabilizing to global markets and detrimental to world growth. So long as the concept of a SIFI exists, and there are institutions so powerful and considered so important that they require special support and different rules, the future of capitalism is at risk and our market economy is in peril.”

Hoenig’s comments on the decline in competition and accountability in banking are especially noteworthy:

“The U.S. economy is the most successful in the history of the world. It achieved this success because it is based on the rules of capitalism, in which private ownership dominates markets and individuals reap the rewards of their success. However, for capitalism to work, businesses, including financial firms, must be allowed, or compelled, to compete freely and openly and must be held accountable for their failures. Only under these conditions do markets objectively allocate credit to those businesses that provide the highest value. For most of our history, the United States held fast to these rules of capitalism. It maintained a relatively open banking and financial system with thousands of banks from small community banks to large global players that allocated credit under this system. As late as 1980, the U.S. banking industry was relatively unconcentrated, with 14,000 commercial banks and the assets of the five largest amounting to 29 percent of total banking organization assets and 14 percent of GDP.

Today, we have a far more concentrated and less competitive banking system. There are fewer banks operating across the country, and the five largest institutions control more than half of the industry’s assets, which is equal to almost 60 percent of GDP. The largest 20 institutions control 80 percent of the industry’s assets, which amounts to about 86 percent of GDP.”

9--Tax rates and job creation in one graph, Ezra Klein, Washington Post

Excerpt: In theory, the GOP is so committed to resisting tax hikes because it’s so committed to creating jobs. “The fact is you can’t tax the very people that we expect to invest in the economy and create jobs,” says Speaker John Boehner. But Michael Linden’s chart comparing average annual job creation at different marginal tax rates begs to differ: "must see" chart

10--How Fast Is the US Dollar’s Share of International Reserves Declining?, Peterson Institute

Excerpt: In the fourth quarter of 2008, the dollar’s value share of all countries’ foreign reserve holdings was 64.1 percent. That share had decreased by 2.7 percentage points by the end of 2010. The dollar’s value share of advanced countries’ reserves was 67.2 percent and decreased by 3.1 percentage points over the eight-quarter period. The euro’s value share in all countries’ reserves decreased slightly over this period, from 26.4 percent at the end of 2008 to 26.3 in the fourth quarter of 2010. On the other hand, the euro’s share of advanced countries’ reserves increased by 2.2 percentage points, from 22.4 percent in the fourth quarter of 2008.

The dollar’s quantity share of all reserves was 66.8 percent in the last quarter of 2008 and 63.3 percent in the last quarter of 2010, a drop of 3.5 percentage points.1 The dollar’s quantity share of advanced countries’ reserves dropped 3.6 percentage points....

The published aggregate IMF COFER data suggest a general diversification away from dollars from the end of 2008 to the end of 2010 with a significant shift toward the euro. However, a substantial portion of this apparent shift away from the dollar can be explained by the Swiss National Bank’s large-scale purchases of foreign exchange over this period combined with the Bank’s preference for euro-denominated assets. Similarly, the shift to euro-denominated assets is largely the consequence of the Swiss National Bank’s operations.

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