Between the holiday slowdown and the number of writing commitments I have it has been a little too easy to neglect my blog. What free time I have has been spent reading, and I am reading for the third time what I think is one of the best books ever written on financial history – Barry Eichengreen’s Golden Fetters: The Gold standard and the Great Depression.
Eichengreen’s book has an awful lot to tell us about our own current crisis, as does any good book on financial history. In spite of all the unending nonsense written about what went caused the financial crisis this time around – derivatives, securitization, deregulation, greedy bankers, overpaid traders, fraudulent behavior – the fact is that financial crises going back over at least 2000 years are disconcertingly familiar, and have nearly identical consequences and processes, even when they include none of the conditions blamed for the current mess. To focus on those particular triggers as being the main causes of the crisis is what I would call the “trigger fallacy.” They are merely the symptoms of the underlying problem – excess liquidity, which the financial system is forced into accommodating by taking on increasingly levels of risk, either inside or outside the regulated areas.
Not surprisingly then it is impossible to read Eichengreen’s book in the current economic climate without several “aha!” moments, but this passage (pp. 11 of the 1992 edition) I found particularly interesting:
The arrival of the Fed on the international scene was a significant departure from the pre-war era. Disputes between New York and Washington rendered the new institution unpredictable. Until the Banking Act of 1935 consolidated power, considerable influence was wielded by reserve city bankers from the interior of the country with little exposure or sympathy for international considerations.
Eichengreen is discussing how the advent of the US as a major financial center changed the “rules of the game” involving cooperation between the major European central banks – mainly the UK, France and Germany – when the closest thing to a US counterpart was the very well-managed and internationalist House of Morgan. During the end of the 1920s and beginning of the 1930s the Fed’s role became increasingly prominent and increasingly erratic especially after the death of Benjamin Strong, who ran the New York Federal Reserve Bank and who had a very strong relationship with Montagu Norman, the Governor of the Bank of England.
The point is that before power was consolidated under the Chairman of the Federal Reserve System in Washington DC, the US central bank consisted of 12 regional banks with quite a lot of independent power, and the regional banks tended to be, not surprisingly, more parochial, more beholden to the dominant economic interests of their region, less understanding of the US role within the global system, and less sympathetic to the need for the US to behave in a manner befitting what was later dubbed a “global stakeholder.”
This had consequences. It was very hard for the US central bank to act in a consistent way to manage its proper role within the global context, and this failure not only created a very debilitating uncertainty, but also ensured that parochial interests trumped international interests even when the US was better off parochially from understanding its role within the international context. For example US trade policies aimed at helping regional economic interests at the expense of the outside world ultimately ensured both a collapse in international trade and, as result of the US position of overcapacity, a brutal collapse in US capacity.
What does this have to do with China? Perhaps nothing, but I am of course not the first to observe that the PBoC has very little independence and is largely beholden to the State Council and senior officials within the Standing Committee for its policy decisions. This is, in itself, not a problem and might even result in better coordination between the country’s treasury and central bank functions. However there are persistent rumors of serious disagreements among senior policymakers and especially a split between one camp, dominated by provincial leaders more concerned about social issues arising from unemployment and income inequality, and another camp, based in the major international center and more concerned about macroeconomic imbalances at both the national and global levels.
Is there a possibility that the PBoC will find itself, like the Federal Reserve in 1929-31, riven by very different understandings of the country’s role within the global crisis and with different priorities in resolving the crisis – ones that misconstrue how the global adjustment will affect China’s adjustment? I have no idea, and perhaps the game of finding parallels between 1929 and 2008 gets a little carried away at times, but it is worth considering that monetary policy-making in China has not always been consistent and, like most major policy-making, can be easily subject to competing views of Chinese political priorities and China’s role within the crisis.
This is not to say that the illusionary triumph of parochial over global interests is inevitable, as occurred in the US in the 1930s, but it certainly is a possibility. This is yet anther reason why I am convinced that US, European, Japanese, and especially Chinese leaders need to get a clear macro picture of what the global balance of payments adjustment will mean for each country, and give up the silly blame game to work out a reasonable long-term period (at least three or four years), during which time China can adjust to the global adjustment. Any quick adjustment will be bad for the world and devastating for China.
But the prospects for understanding don’t look good. Local newspapers are filled with worried articles about rising unemployment, and on Saturday Premier Wen made an unscheduled and very surprising visit to one of our academic neighbors. According to an article in today’s People’s Daily:
Chinese Premier Wen Jiabao has pledged to university student that the government would seek to provide more jobs for graduates and “put the issue of graduate employment first.” “Your difficulties are my difficulties, and if you are worried, I am more worried than you,” Wen told the students at the Beijing University of Aeronautics and Astronautics. Wen made the remarks in a surprise visit on Saturday afternoon.
…He said the country is in a difficult period as the global financial crisis has continued affecting the country’s real economy. The government has begun measures to sustain the economy, such as the four-trillion-yuan stimulus package and interests cuts. “We are considering taking more measures at proper time. But currently we are most concerned about two issues, migrant workers returning home and employment for graduates,” Wen said.
The financial crisis and China’s slowing economic growth has forced 4 million migrant workers to return to their rural homes, according to a report from the Chinese Academy of Social Sciences. The report also said as of the end of this year, 1.5 million graduates are likely to have failed to find jobs, and the country could see an ever tougher employment situation in 2009 as there will be about 6.1 million seeking jobs (from 5 million last year).
Other headlines fret about the mass migration – well before the traditional Spring Festival period – of unemployed workers returning to their rural homes. According to an article in Friday’s South China Morning Post:
Up to 9 million migrant workers have left coastal areas this year amid diminishing job prospects and falling wages, prompting fears that unemployment in inland provinces may increase sharply next year. Home-bound migrant workers have packed major railway stations in major cities, catching the central government by surprise because the traditional passenger peak arrives just before the Lunar New Year, which is late next month.
There is still more about the rise of criminal gangs, more protests, and all the other indications of social tension. In these circumstances it is not hard to see why policymakers may decide that short-term unemployment pressures trump the global balance of payments adjustment, and push to subsidize and encourage more production, rather than worry about rapidly expanding domestic consumption. This would, of course, only exacerbate the Chinese overcapacity problem and increase the likelihood of trade tensions which, if they lead to global protectionism, could scuttle any chances of China’s recovering from the crisis. I guess this is exactly what they mean by “between a rock and a hard place.”
One other thing to discuss before I finish this long posting – Bloomberg posted the following article today:
China’s foreign exchange reserves dropped for the first time in five years as a result of the global financial crisis, Market News International reported, citing Cai Qiusheng, head of the investment management bureau under the State Administration of Foreign Exchange. The current figure must be lower than the peak of about $1.9 trillion, Cai told a trade forum in Beijing over the weekend, the English-language wire service said. He didn’t specify which period he was referring to or give a figure.
I am not really sure what is going on. We used to get regular and reliable monthly leaks about reserve figures but these have pretty much dried up since June, just as we needed the numbers more than ever. The last official numbers were released for September – they are released on a quarterly basis – and put reserves at $1.9056 trillion. The latest “leak” claims reserves are at $1.89 trillion, which with rounding suggests that reserves declined in two months by somewhere between $10 and $20 billion.
Of course we are all very eager to get a better breakdown of the recent figures so that we can estimate hot money flow directions. But given the we have had two world-record-smashing trade surplus months in a row since September, amounting to $75 billion (and three monthly world records before that), not to monition positive FDI inflows of $14 billion and about $10 billion of interest income in the past two months, it is very unlikely that the dollar value of the various non-dollar reserves can have declined by even a significant fraction of $99 billion increase in reserves from trade, FDI and interest income in the past two months (or the $110-120 billion implied by the new reserve numbers). Does this mean there has been significant hot money outflow? Perhaps, but without real numbers it is tough to want to conclude anything. January’s central bank data release promises to be very, very interesting.
But there’s more. My friend Victor Shih published a very good Op Ed article in the Wall Street Journal Asian last week. You can find it on his blog. He discusses how the new fiscal expansion plans – which are seriously constrained by structural impediments in the economy – are likely to cause significant pressure for bank “participation,” and this pressure is unlikely to lead to improved banking practices. He concludes:
In any event, everyone is too preoccupied with their own losses to comment on Chinese policies. Which is a problem, not least for China itself. With enormous political pressure from the central government to pump money into the economy and silence from the rest of the world, much of the work in the past decade is being undone.
What will happen to all this money? Stephen Green – one of the best bank research analysts on China, in my humble opinion – just published a research report called China – The best-laid plans of mandarins and ministers in which he tries to tabulate the various spending plans being proposed at the national and provincial levels. Not surprisingly, he has a hard time figuring out the numbers – one section of his report is titled “CNY 4trn, CNY 18trn, or CNY 320bn?”
The government is so worried about a slowdown that there is almost a feeding frenzy over who can proclaim the most spending – with very poor Hunan proposing $1.2 trillion in expenditures that surpass the entire US fiscal plan, as Green notes. Even if most of these proposals are rejected, clearly an awful lot of money is going to be spent awfully quickly with an awfully small amount of oversight. Elsewhere in the report Green notes:
One suspects that corners are now being cut to get the money flowing again. The bureaucracy must also be exceedingly happy; it is commonly believed that 15-30% of the cost of a project is absorbed by ‘administrative’ fees, ‘consultancy’ fees, and the like (which raises the question of whether we should be discounting the CNY 4trn by 20% or so, and assuming these other funds will form part of 2009’s FX capital outflows). The Party’s corruption inspectorate is already preparing teams to monitor the use of public and bank funds. But it is, as they say, a big country.
It certainly is. And yes, we should be increasing our estimates of hot money outflows next year.
Happy holidays to all my readers. Unless there is a lot of important news in the next few days I will probably not post anything for a week. For those living in Beijing, we do have an outstanding Christmas Eve show at my music club, D22, and another outrageous night on New Year ’s Eve. If you want a good feel for some of the best new music in China (and the world), don’t miss these two nights. Sorry for the advertisement, but the Beijing music scene is truly exciting.