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Political Resilience Is Being Confident To Face Ugly Truths, Knowing Your System Will Survive The Encounter

AFTER AMERICA RODE A TIDAL WAVE OF ECONOMIC INTEGRATION AND EXPANSION FOLLOWING ITS CIVIL WAR (MOVING RAPIDLY FROM A SECTIONAL ECONOMY TO A TRULY CONTINENTAL ONE), A FRIGHTENING STRETCH OF BOOMS AND BUSTS IGNITED A LENGTHY PROGRESSIVE ERA (BREAKING FOR THE ROARIN' TWENTIES) WHEN POLITICAL ACTORS FROM BOTH PARTIES SOUGHT SYSTEMIC REFORMS - LEST THE COUNTRY SUCCUMB TO THE SORT OF RADICALISM LOOMING IN EUROPE (SEE FALLOUT OF WWI, CAUSES OF WWII). It was a frightening journey in many ways, with worried leaders concerned that the very nature of American democracy was at stake. But this is the usual price to be paid in return for a radical and lengthy expansion of economic activity, and it's one the world faces today after that quarter-century-plus boom that ended in 2008-09 and left the global economy with a bad hangover of toxic debt that is still largely to be processed.

Per a solid NYT story of late:

Beneath the surface of the global financial system lurks a multitrillion-dollar problem that could sap the strength of large economies for years to come.

The problem is the giant, stagnant pool of loans that companies and people around the world are struggling to pay back. Bad debts have been a drag on economic activity ever since the financial crisis of 2008, but in recent months, the threat posed by an overhang of bad loans appears to be rising. China is the biggest source of worry. Some analysts estimate that China’s troubled credit could exceed $5 trillion, a staggering number that is equivalent to half the size of the country’s annual economic output ...

But it’s not just China. Wherever governments and central banks unleashed aggressive stimulus policies in recent years, a toxic debt hangover has followed. In the United States, it took many months for mortgage defaults to fall after the most recent housing bust — and energy companies are struggling to pay off the cheap money that they borrowed to pile into the shale boom ...

In theory, it makes sense for banks to swiftly recognize the losses embedded in bad loans — and then make up for those losses by raising fresh capital. The cleaned-up banks are more likely to start lending again — and thus play their part in fueling the recovery.

But in reality, this approach can be difficult to carry out. Recognizing losses on bad loans can mean pushing corporate borrowers into bankruptcy and households into foreclosure. Such disruption can send a chill through the economy, require unpopular taxpayer bailouts and have painful social consequences. And in some cases, the banks might find it extremely difficult to raise fresh capital in the markets.

Sounds like recent American history, yes? It's 2016 but there's still palpable anger over the Wall Street bailouts and far too many Americans still struggle with unsustainable credit debt. But, by way of comparison, the U.S. dealt with the financial crisis with genuine speed.

Yes, op-ed columnists are still arguing about the bailouts and the stimulus spending (the latter being somewhat irrelevant to curing a financial crisis), with plenty still arguing for more spending (like Paul Krugman).  And we most certainly have endured a strange era of name-calling: remember when President Obama was a "socialist" in the eyes of his enemies?

But now we have a serious Democratic candidate for president in Bernie Sanders who embraces the Social-Democrat moniker, and he gets enough traction with that to force Secretary Clinton into making her own claims at the progressive label.  On the other side, Republican candidates are struggling with the terms but reaching for the same sense of popular desperation - the feeling that the middle class has been under assault for years now. It's just that too many candidates in the GOP are having trouble separating that valid concern from the sort of anti-immigrant sentiment that is historically attached to such fears.

Still, all this shouting and posturing and name-calling reflects something positive: compared to the rest of the world, America was more confident in processing its toxic debt overhang. Plenty of work to be done, but the job is engaged. What the NYT article laments is the lack of similar progress elsewhere, and, in my mind, that progress reflects a political lack of confidence in the systems afflicted - one that prevents them from moving more aggressively because they fear the very fabric of their governments' political legitimacy might tear.

China is the scariest example in this regard.  Per the chart above, we see just how integrated and important the Middle Kingdom has become with regard to the global economy's functioning. Scarier still is the damaging precedent set by neighboring Japan:

Japan, economists say, waited far too long after its credit boom of the 1980s to force its banks to recognize huge losses — and the economy suffered for years after as a result.

But Japan stalled out during the go-go nineties, so it could only do so much damage on a global scale. But, as the world went on a growth tear over the next decade and a half, the stakes today are so much larger - as is the poster-child for not facing the truth with enough alacrity - again, China.

Headline figures for bad loans in China most likely do not capture the size of the problem, analysts say. In her analysis, [one prominent local observer] estimates that at the end of 2016, as much as 22 percent of the Chinese financial system’s loans and assets will be “nonperforming,” a banking industry term used to describe when a borrower has fallen behind on payments or is stressed in ways that make full repayment unlikely. In dollar terms, that works out to $6.6 trillion of troubled loans and assets.

None of that was truly unexpected.  You spend your way out of a financial crisis and you're simply delaying your day of reckoning - an essentially political process of regrading the economic landscape like the two Roosevelts (Theodore and Franklin) once did for the U.S. under similarly tumultuous circumstances (may I suggest Ken Burns' 14-hour documentary "The Roosevelts" on Netflix).

It's just that no one can spot that sort of leadership in China right now. We've seen some experts compare Chinese president Xi Jinxing to T.R. in terms of foreign policy machismo (largely on display only in the South China Sea), and Xi has definitely earned his corruption-busting stripes for his lengthy recent domestic campaign. But processing China's frightening large pool of toxic debt?

The looming question for the global economy, however, is how China might deal with a vast pool of bad debts.

After a previous credit boom in the 1990s, the Chinese government provided financial support to help clean up the country’s banks. But the cost of similar interventions today could be dauntingly high given the size of the latest credit boom. And more immediately, rising bad debts could crimp lending to strong companies, undermining economic growth in the process.

“My sense is that the Chinese policy makers seem like a deer in the headlights,” Mr. Balding said. “They really don’t know what to do.”

And that, my friends, is the biggest uncertainty right now in the global system. ISIS, for all its ferocity and atrocities, does not compare.  Sanders/Clinton v Trump/Cruz/Rubio does not compare. The Brexit/Grexit/Whoxit? dynamic in the EU does not compare.

And this is where multiparty, pluralistic democracies rule - when they choose to. They can "throw the bums out."  Heck, they're required to in the U.S. after 8 years - maximum (our presidential administration). Being able to apply the "clean slate" is a huge act of political resiliency, one that China, with its single-party state, is presently unable to employ.

And that is worrisome for the entire global economy as it continues to process the toxic overhang from that great global economic expansion that we all now remember so fondly.




Africa: investments and insurgents

Pair of WSJ stories:  first one on Carlyle Group joining the list of private equity firms rushing in with yet another Sub-Saharan Fund; and second on EU debating whether to fund a cohort of West African states looking to combat the radical Islamic militias that have taken over northern Mali with the intention of setting up their own separate state.

The combination is - to me - telling of that dynamic of rapid frontier integration that I'm always going on about.

Africa is, of course, not really a frontier in a settling sense, but it is one in a globalization-investment-trade sense.  And when you're a frontier in that sense, it's not surprising to see both dynamics in play, as the "rush" of connectivity creates its own blowback (the central theme of my books).

From the first piece:

The investments, and Carlyle's nascent Sub-Saharan Fund, targeted at $500 million, show how private-equity firms are trying to position themselves to tap into the continent's new consumers as well as companies that are expanding on the back of demand for food and energy from the rest of the world.  Competition among global rivals is heating up in Africa, as investment returns diminish in more developed parts of the world.

From the second piece:

West Africa countries are trying to set up the force to help Mali to regain control of its northern half, which is under the sway of the al Qaeda affiliate, known as al Qaeda in the Islamic Maghreb, or AQIM.  The nations say northern Malie is becoming a haven for violent groups that live off kidnapping and trafficking as well as a training ground for terrorists who could destabilize the whole region.

I mean, seriously, I bet I could find you similar stories in U.S. East Coast newspapers from 1870-something that describe new funds and new military efforts being launched for the American West.

The speed of both dynamics is, in terms relative to even our recent past, rather stunning.  The worst thing I wrote in The Pentagon's New Map concerned my pessimism over Africa's future.  I just had the whole thing taking far longer than it is.

And that's a real lesson for me.


Chart of the day: World greatest aid flow keeps getting greater

WSJ story noting that:

Migrant workers abroad sent more money to their families in the developing world last year than in 2010, and they are expected to transfer even more cash home this year despite the economic uncertainly gripping the globe.

You can see the divot created by the financial crash in 2008, but note how the trajectory resumes like it never even happened.

The number is staggering:  $372B last year.  World Bank predicts almost half a trillion will flow in 2014.

Key bit:

Remittances remain a key source of hard currency for developing countries, often outstripping foreign direct investment and foreign aid.

It can "immunize" your country from downturns, so sayeth a new WB book on the subject.

Both intra- and inter-regional flows are rising in same manner, with key technological enabler being how cheap it is for ordinary people to wire money.  

One of the biggest players in this realm at about 1/7th of global market?  Western Union.

How's that for a frontier metaphor?  Back then it was all about telegraphs.  Now it's all about remittances.


Brilliant movie-chart on Kiva loans from Core to Gap

HT to Thomas Frazel at Tulane.

I wrote about Kiva in Great Powers, naturally, because there my focus was on subnational and transnational actors (the trilogy, in Waltzian terms, went PNM = system, BFA = states, and GP = trans/subnational & individuals).

No surprise on the flows here: it's virtually all Core to Gap (wait for the "actor" credits at the end).

What I saw were four big flows:

1) US to Africa

2) US to Greater Middle East

3) US to Asia

4)Europe to Asia.


Fascinating stuff.


Meanwhile, I'm on the road giving a speech to a financial conference in Atlanta.


Red Dawn! Chinese state banks to enter US market

You just want to summon your inner Yakov Smirnov:

In America, banks loan you money.

In China, you loan banks money!

WSj front-page lead on "Chinese banks get nod in U.S."  The Fed Reserve okayed 3 state-run banks to enter and apparently didn't stop the first ever acquisition of a U.S. retail bank by one of them.

The goal of Chinese banks?  Initially, to service Chinese companies operating overseas and those foreign investors looking for "exposure" to the renminbi.

Exposure is the key word here - in both directions.  But, in general, I heartily approve.

China is the biggest saver in the system these past couple decades.  So yeah, access is crucial for an economy with shakey finances.

Of course, China's financial system has its own dangers, but - again - in general I greatly approve of even more financial interdependence.  

It'll help keep the China crazies inside the Pentagon on a leash.


Chart of the day: remittance "corridors"

From the Economist.

I just love global maps indicating flows - naturally.

What do we see here?

Per my vernacular, in sheer volumen we see New Core being fed remittances by expats living in Old Core.  But when it comes to countries relying heavily on remittances as percentage of GDP, it tends to be mostly Old/some New Core and it all pretty much goes to Gap countries.

Per my flow concept:  whatever the resource, it flows from regions where it is plentiful (here, earning opportunities) to where it is less so.  Yes, we think of India, China, Mexico as New Core and thus "made," but all share the reality of significant numbers of rural poor.  In truth, in most New Core countries, there is massive internal remittances flows.

What I love about this:  this is the best foreign aid there is, because people use it as they see fit.  

You may say to yourself:  What a drain on Core - especially US!

Studies have shown, however, that expats living in new countries spend something like 90% of their earnings in-country, sending about 1/10th home.  It's just that those flows still number in the billions, swamping anything we do on official developmental aid.


Charts of the day: US debt and petroleum

From Business Insider (via Zakaria's GPS site) comes the following listing of who holds US public debt.

  • Hong Kong: $121.9 billion (0.9 percent)
  • Caribbean banking centers: $148.3 (1 percent)
  • Taiwan: $153.4 billion (1.1 percent)
  • Brazil: $211.4 billion (1.5 percent)
  • Oil exporting countries: $229.8 billion (1.6 percent)
  • Mutual funds: $300.5 billion (2 percent)
  • Commercial banks: $301.8 billion (2.1 percent)
  • State, local and federal retirement funds: $320.9 billion (2.2 percent)
  • Money market mutual funds: $337.7 billion (2.4 percent)
  • United Kingdom: $346.5 billion (2.4 percent)
  • Private pension funds: $504.7 billion (3.5 percent)
  • State and local governments: $506.1 billion (3.5 percent)
  • Japan: $912.4 billion (6.4 percent)
  • U.S. households: $959.4 billion (6.6 percent)
  • China: $1.16 trillion (8 percent)
  • The U.S. Treasury: $1.63 trillion (11.3 percent)
  • Social Security trust fund: $2.67 trillion (19 percent)

The Global Post's Tom Mucha writes the post as revelation: See! China doesn't own the U.S.

Okay, so China doesn't own the US anymore than we get all our energy from Saudi Arabia, but China is the single biggest foreign holder - more than 3 times the long-time historical champ UK and more than recent historical champ Japan.

And yes, we do get a picture sort of like our oil situation, where our biggest supplier remains ourself (here, in various forms, accounting for roughly 2/3rds) and other big suppliers remains long-time friends.

But what's also been clear when we've floated large amounts recently is that China is the one great foreign buyer out there who can soak up our surges, so it does play a bit of a Saudi Arabia-like role in things, and that's not to be dismissed.

Then also via Zakaria' site comes the following US Energy Information Agency chart:

The clear long-term trend here, per the North American energy export boom in the works (Wikistrat's next community simulation to begin shortly), is the declining role of petroleum imports, dropping from the high in 2005 (60%) to under half today (49%) and down to just over a third (36%) by 2035.

Things you note:


  • Flatness of demand curve!
  • Significant rise in production - part of the fracking revolution!


The combo yields America's resumption of its role as a net exporter of petroleum products for the first time in over six decades!

Compare that picture to China's and ask yourself if you'd switch energy challenges with them.

Of course not.

But back to the first point: China is the big saver in the system of the last two-three decades. That means it's not only our great release-valve source of money for things like our national debt. It plays that role increasingly around the globe - to wit, the recent Wikistrat sim on "China as the de facto World Bank for Africa."

My point in the pairing: excitement over our improved energy picture, yes, but realism on the future of money - especially given this fear-threat reaction embodied in Obama's strategic "pivot" to China.


This week in globalization


Clearing out my files for the week:


  • Martin Wolf on why the US is going to win the global currency battle:  "To put it crudely, the US wants to inflate the rest of the world, while the latter is trying to deflate the US."  We win because we have infinite ammo.  But better that we come, per my Monday column, to some agreement at the G-20. 
  • Sebastian Mallaby, also in FT, says that, despite the current currency struggles, the "genie of global finance is out of the bottle" and not to be stuffed back in.  Wolf had noted $800B capital inflows to emerging markets 2010-2011, which is gargantuan, thus the crazy struggle of some places to keep their currencies low.  As for America stopping China from buying US bonds in retaliation for our not being able to buy Chinese assets?  China holds only about one-third of the US T-bonds abroad ($3T total), so it can buy all its wants from others in the system.  There is no turning back, he says.
  • Meanwhile, the Pentagon makes plans to turn back the clock on the globalization of defense manufacturing.  A new spending bill provision--inserted at DoD's request--includes the power to exclude foreign parts suppliers (read China). Just about every US-based defense firm uses offshore suppliers, so this is going to get very expensive very fast.  It'll be a lot harder to find that $100B in savings over five years. This is almost a fifth generation warfare version of shooting yourself in the foot--first, before the other guy can.  China does nothing here, that frankly we shouldn't be able to handle, but we move down a path that instantly adds a significant tax to everything we buy in the growing-by-leaps-and-bounds IT realm.  One hopes there's a half-billion for that American rare earths mining co. that's looking for a new investor.  Interesting how China's becoming vulnerable to, and dependent on, so many unstable parts of the world for resources, and we're going to cut off the tip of our IT nose to spite our face.  I can imagine a cheaper way, but that would be so naive in comparison to spending all this extra money.
  • China continues to buy low, as a ruthless capitalist should. Giving us a taste of what it could be like if we don't get too protectionist, it's buying up Greece's "toxic government bonds."--and plenty more in Europe. All of the EU is getting a taste, says Newsweek, as Chinese investors are snapping up bankrupt enterprises and--apparently--putting people back to work.  China also, like a ruthless capitalist, seeks to make bilats reduce the chance of EU-wide restrictions on its trade. Old American trick.
  • Another sign of globalization on the march:  emerging economies buying up food and beverage companies in the West that would otherwise naturally be targeting them for future expansion. Bankers expect the trend to continue.  Gotta feed and water that global middle class that keeps emerging at 70-75m a year.  Emerging economies are buying up the companies from equity firms that had previously bought them during down times.
  • Great FT story on how Turkey has the Iranian middle class in its sights.  Long history of smuggling inTurkey dips a toe in, would like to drink entire tub eastern Turkey.  Sanctions hold up what could be a major trade, so the black-marketing local Turks mostly smuggle gasoline--and a certain amount of heroin.  But the official goal is clear enough:  be ready to take advantage whenever Iran opens up.  A local Turkish chamber of commerce official floats the notion of a free trade zone at the border. Those 70m underserved Iranian consumers beckon.
  • India's airline industry can't keep up with demand generated by itsGet me planes and pilots--now! booming middle class. Boeing says Indian airlines will buy over 1,000 jets in the next two decades. Already they're forced to have one-in-five pilots be foreigners.
  • Fascinating WSJ story on how China's car economy is going wild, with ordinary Chinese exploring the freedom of the road.  Drive-in service is taking off, weekend jaunts mean hotel business, etc. In past visits I saw a lot of this coming down the pike.  Just like when America's car culture went crazy after WWII, this is a serious social revolution.

Don't forget your meal of eternal happiness!

  • Funny thing about all this South China Sea hubbub: "Corporate ties linking China and Japan have never been stronger," says the WSJ.  Serious driver?  Japan is exporting its mania for golf to China--the fastest growing market for the sport.  It's what middle-class guys do.

Coming soon: the "golf wars"


  • WSJ story on Vietnam creating its own Facebook to keep a closer eye on its netizens.  Defeat the anti-capitalist insurgents!What caught my attention: "The team has added online English tests and several state-approved video games, including a violent multi-player contest featuring a band of militants bent on stopping the spread of global capitalism."  I would say we finally won the Vietnam War.



Drug war logic repeated on China currency question

Lemme see: inside every Chinese peasant is an American consumer just waiting to break free!

Stephen Roach piece in WSJ.  He's the former Asia head for Morgan Stanley now back to Yale.

Roach is one of those economists who points out that past experience with Japan says gets a revalued currency won't change our foreign trade deficit with China, which is really with Asia as a whole and has been consolidated by China over the past decade or more through its efforts to become the final assembler of note.

Some bits:

The currency fix won’t work. At best, it is a circuitous solution that would address only one of the many pressures shaping the imbalances between our two nations; at worst, it would lead to a trade war, or risk jeopardizing China’s understandable focus on financial and economic stability.

Besides, in a highly competitive world, there are no guarantees that currency shifts would be passed through to foreign customers in the form of price adjustments that might narrow trade imbalances. Similar fixes certainly didn’t work for Japan in the late 1980s, and haven’t worked for the United States in recent years . . . 

Contrary to accepted wisdom, America does not have a bilateral trade problem with China — it has a multilateral trade problem with a broad cross-section of countries.

And why do we have these deficits? Because Americans don’t save. Adjusted for depreciation, America’s net national saving rate — the sum of savings by individuals, businesses and the government sector — fell below zero in 2008 and hit -2.3 percent of national income in 2009. This is a truly astonishing development. No leading nation in modern history has ever had such a huge shortfall of saving. And to plug that gap, we’re left to borrow and to attract capital from lenders like China, Japan and Germany, which have surplus savings.

If Washington were to restrict trade with China — either by pushing the Chinese currency sharply higher or by imposing sanctions — it would only backfire. China could very well retaliate against American exporters, and buy goods from elsewhere (a worrisome development in what is now America’s third-largest export market). Or it could start to limit its purchase of Treasury securities.

The United States would then have to turn to some other nation or nations, at a higher cost, to finance our budget deficits and make up for our subpar domestic savings. The result would be an even weaker dollar and increased long-term interest rates. Worse still, as trade was redirected away from China, already hard-pressed American families would be forced to buy products that are noticeably more expensive than Chinese-made imports.

But Washington remains unwilling to address our unprecedented saving gap, and instead tries to duck responsibility by blaming China. Scapegoating may be good politics, but proposing a bilateral fix for a multilateral problem is just bad economics.

China should stay the course with its measured currency reforms, allowing the renminbi to continue to appreciate gradually and steadily over time. Contrary to the inflammatory rhetoric of China’s critics, this is not “manipulation.” It is a reasonable strategy to anchor the renminbi to the world’s reserve currency, the dollar, in an effort to maintain financial stability in an all-too-unstable world.

True, but by doing so (see reference #2), China is creating a beggar-thy-neighbor bandwagon effect, as Taiwan, Japan and South Korea all start intervening to keep their currencies cheaper, to the point where Brazil's finance minister declares that an "international currency war" has broken out.

Roach then goes on to talk about fixing China's low consumption rate (only 35% of GDP, or about half of the US), but here I think he falls into the trap that Michael Pettis warns about: there is no easy shifting from investment driving most growth to consumption stepping up.  In short, anything but a slow redirect gets a crash, and so long as the redirect is slow, it's unlike to effect a serious shift.  When you stack those two analyses one on top of the other, you get the feeling that China will go on as it does (addicted to exports) until a crash there forces otherwise.  It would seem we've taken sufficient lumps to force the necessary change here--one hopes, which is the big reason why we feel so down on ourselves right now while wildly elevating China in our minds.

But as I like to say, the China model is brilliant until the first big crash.

The thought that prompted the post was that, just like in the drug war, we want our "enemy" to stop exporting so much of that stuff to the U.S., when it's our demand for that stuff and our lack of self-control which is the real issue.  But as Roach points out, we don't like to deal with our own issues, and in a classic psychological trip, we transfer our anger over our lack of self-control by blaming our "dealer."

Not exactly the Opium Wars, but you get my drift.


Learning from the yen

FT column by Gillian Tett says to read journalist-cum-banker Taggart Murphy's history of the yen to understand the way ahead on the renminbi, also considered to be held to artificially low value by its government.

But what caused the trade imbalance, argues Murphy was: 1) the US Fed deficit structurally built into the body politic by Reagan, and 2) the Japanese "development state" system of national leverage, centralized credit allocation and credit risk socialization (the govs stood behind banks).

That's all ancient history now, and Japan's gov today intervenes to weaken the strong yen.  

Tett says just read the book and swap out Japan for China and it all makes sense all over again.

This has been my argument in the brief for a couple of years now--a grand strategic choice by America that enabled export-driven growth in Asia while allowing us to: 1) be a military superpower and 2) ask for no sacrifice from society because money remained so cheap.

How did Japan escape the grind?  Not well.  (And the same can be said for us today.)  Japan worked to spur domestic demand while keeping exports strong, and that paved the way "for a crazy bubble, followed by a bust, and more currency instability in subsequent years."

Murphy's point:  "Changing the units of account had not the slightest chance of dealing with these fundamentals.  But they made for a more unstable world."

In other words, be careful what you wish for.

This is a consensus argument I find:  it's not the pegging that hurts us but the sterilization of the foreign currency won in the process (i.e., China's continued insistence of controlling its allocation in a macro sense).

What went wrong with Japan is that it outgrew the need for central control of capital allocation via a state-dominated banking system.  It outgrew that system like a child outgrows shoes, says Tett.  But it waited too long to reform the system--the same danger that awaits China, one imagines.

And yet, China claims to be growing up its system as fast as possible.  Tett says the pace remains too slow.

Macro lesson of Murphy's book:  the twin dangers of rapid revaluation and too slow reforms.  In between lies the sweet spot of making capital allocation more marketized and efficient, letting in a reasonable amount of inflation but not too much.

Old story I would add:  centralized and authoritarian works for extensive growth under conditions of scarce capital, as centralized allocation allows the state to direct growth.  But once the economy matures or "complexifies" sufficiently, the system outgrows the crudity of that initial system and needs the wisdom of crowds larger than can be assembled in one room in Beijing.


The ability of foreign banks to tap into China's market remains stunted

Gist of WSJ article:  foreign bank profits took sharp fall last year while Chinese banks posted double-digit percentage gains.

The problem:

Foreign banks have long struggled to build a business of any scale, since they are reined in by Chinese regulatory limits on how much local banking operations can lean on foreign parents.

The local logic?  Insulating the economy from foreign financial shocks.  But this means foreign banks can't open much in the way of new branches--thus offering local banks better competition, which presumably would aid the Chinese consumer.

All of this from KPMG report which ferrets this stuff out, because foreign banks do not disclose much about their ops in China, and rarely speak critically of the government.


Basel III derided further

Ft full-pager says Basel III et al will have the cumulative impact of driving investment money from banks to non-banks.  The killer quote from an expert on financial regs:  "It's now one-third more expensive to do business with banks, a powerful incentive to use non-banks" like hedge funds and other entities.

So the question becomes, how much of the money will escape "sectoral regulation."

A found description of non-bank lending:

Non-Bank Lending

Non-banks are ordinary intermediaries.  They act as a conduit between those with funds to lend and those in need of funds.  By pooling the funds of investors from whom they borrow, they can then lend in various amounts and periods.  For their service they charge a fee, usually in the form of periodic interest payments.  Their borrowing and lending increases the total credit market debt but has no direct effect on the money supply.  Non-banks simply intermediate the transfer of funds from the bank accounts of the original investors to the bank accounts of the ultimate borrowers.  

Non-banks usually borrow short-term at lower rates to lend longer term at higher rates.  That means a non-bank must be able to roll over its short-term debt at favorable rates.  It must also be able to borrow on short notice to manage any cash flow problem.  For that reason it must maintain an excellent credit rating, or it may not be able to borrow at all.  

A general rule:  for every crisis there is a new rule set, the response to which (either going overboard or escaping its grasp) usually sets the table for the next crisis.  Such is life.

Martin Wolf is among those unimpressed by Basel III, describing it as "the mouse that did not roar" (a great Peter Sellers' film):

To celebrate the second anniversary of the fall of Lehman, the mountain of Basel has laboured mightily and brought forth a mouse. Needless to say, the banking industry will insist the mouse is a tiger about to gobble up the world economy. Such special pleading – of which this pampered industry is a master – should be ignored: withdrawing incentives for reckless behaviour is not a cost to society; it is costly to the beneficiaries. The latter must not be confused with the former. The world needs a smaller and safer banking industry. The defect of the new rules is that they will fail to deliver this.

His basic complaint is that the amount of equity required is "far below" the levels markets would naturally demand if there was no chance of government bailout--so bad pricing of risk.  He then makes a case for much higher levels that he says wouldn't crimp the industry as much as feared.


Basel III--the directors' cut

FT, a while back, ran a full-pager analysis that said Basel III?  Ho hum, as the banking industry's regulators were cowed by the efforts of industry lobbyists into diluting the new rule-set package.

Still, when the deal was done last weekend, a lot of pubs hailed its historic nature.  So yeah, higher capital standards for banks, but not so high that most don't already meet them.  As for smaller banks?  Tougher row to hoe

Basel III is described as being different from what the US did under Obama:  "prescriptive rules to steer U.S. banks away from past errors."  Instead, Basel III allows the risky behavior to continue so long as the banks set up bigger capital cushions to absorb losses.

As rule-set resets go, a sort of reversal of the usual philosophies, with the global rules being more passive while ours are more active.   

The big thing, of course, is that some global rule-set package was agreed upon in the first place.

And yeah, markets around the world seemed to like that.

Is the reset finished?  Mebbe . . . mebbe not.  Some banks fear their national regulators will now step in with tougher standards, leading to "regulatory arbitrage" whereby banks seek out the locales with the loosest rules and shun those with the toughest.

A never-ending struggle . . ..


Malaysia continues to play lead goose on Islamic finance

Bloomberg Businessweek blurb on how Malaysia still rules in Islamic finance, an old theme of mine that runs all the way back to PNM.

The market, which came out of nowhere about a decade ago, is slated to be worth $1.6T by 2012.  Islamic finance simply gets around the Koranic restrictions on interest by designating acceptable sources as the equivalent provider of interest payments.  For example, an Islamic bond pays holders a share of the issuer's profits rather than interest.

While a host of Persian Gulf powers angle to dominate the market there, the real action, says the mag, is in East Asia, where Malaysia and Indonesia use such approaches to attract foreign direct investment.  A big advantage for Malaysia:

Malaysia last year introduced an online trading platform for murabahah transactions, in which banks and companies buy and sell commodities based on a price that includes an agreed-upon profit margin that complies with shariah principles.

Moves such as these have given Malaysia a far deeper and more liquid bond market than its rivals.

Good stuff that shows that the "clash," such as it is, lies within civilizations and not between them.


New banking rules underwhelm--by default

FT full-page analysis on new banking rules out of Basel, to be known as Basel III (the third great rule-set to emerge over the years).

The main changes:

. . . tightens the definition of what banks can count as highest-quality "tier one capital"--the main assets they hold to protect against losses.  It also requires lenders to hold liquid assets sufficient to see them through a 30-day crisis and sets a global "leverage ratio" to limit overall bank borrowing.

Why many experts are underwhelmed:  on every point, the initial draft of new rules was more stringent, only to be watered down after heavy lobbying by big banks.

But the FT says, on the basis of a quiet survey of the regulators themselves, that the real reason why the rules were watered down was fear of sabotaging the weak recovery--not the lobbying of banks. The initial draft, say the regulators, simply created too much fear across the industry.  The original liquidity rule, for example, was considered exorbitant.  As one regulator put it, "There isn't enough stable funding in the world to meet the requirements."

My take-away:  the global financial system remains too heterogeneous for a tough new blanket of rules.  We have varying levels of maturity across the board--as in, so many frontier economies, so few rules that everyone can follow to the same degree.

The financial crisis hit the system too early for such tough, across-the-board regulations, and so we await the Great Rebalancing (which no one is quite sure how to achieve without great trade protectionism on the part of the debtor states) for such rules to emerge.  Until then, we have too many differing economies trying to do too many different things for uniform rules to emerge.


Beijing floats the notion of a basket value-setter for the yuan

A good and hopeful sign announced in a WSJ story: 

China will consider publishing a so-called effective exchange rate for the yuan against a range of other currencies in an effort to de-emphasize its value against the dollar, a further indication of how Beijing plans to manage the yuan since effectively decoupling it from the U.S. currency.

Last bit seems a bit kind: China announced a decoupling and we go a nice little spike there right off the bat, but a bit pokey since.

Still, this is a good and smart and inevitably move by Beijing, and something I’ve been arguing for going back several years:  the need for an “asia” to join the euro in balancing the dollar. We all know the yuan will be its center of gravity, just like China will play Germany in an Asian Union, and so I chose—not too naively, I believe—to interpret this as a small step in that direction.

The basket of currencies is expected to be based on the host of major currencies of countries/union with whom China has the most trade.

Skeptics cite the vagueness of the description from the vice governor of the People’s Bank of China, and no doubt there will be zigging and zagging and nothing done with any great speed.  The point is just the floating of the concept for now.

A strict linking of the yuan to a basket of currencies is unlikely in the near term, analysts say, as it would mean the yuan could fall against the dollar when the greenback is rising against other currencies, which could enrage parties in the U.S. calling for yuan appreciation.

So, for now, experts describe the announcement as part of an “education campaign” designed to get parties both inside and outside China used to thinking about its inevitability.

Again, a good, smart move by China.


Brief Reminder: The 2008 financial contagion = the un-Gap (2009)

A slide I still use in the brief to show a real-world example of the Core-Gap divide.

Core countries are the reddish ones, meaning they experienced fast and furious downward market pressure once the contagion began.  The degree of change is measured across the first 90 days.  And if you toss Indonesia into the Core, as I am increasingly wont to do, the match is that much tighter.

The mostly grayed-out Gap is explained two ways:  1) no real markets; or 2) where markets exist, not much tied to Western ones.

Eventually the slowdown reaches the Gap through the reduced commodity demand of the Core, but Africa, for example, continues to grow--ever so slightly--even through the worst stretch.


Chart of the day: China's banks moving on up

Economist story on IPO for China's huge Agricultural Bank, which, BTW, raised about $19B and will end up with $22B when all is said and done--the biggest IPO in history when all the additional possible shares are issued.

The event, says The Economist, "ends a decade-long process to transform China’s huge financial institutions from wards of the state to banks that resemble publicly listed firms in the rich world."

Now that the catch-up has occurred, warns the newspaper,
"success will force the model to change."

So no "Beijing consensus," says The Economist.  "Though neat, such a conclusion looks wrongheaded."

Not that Ag Bank's future isn't bright. It has 320m customers and only 1% of them have mortgages, so growth is guaranteed.

And yes, the government could easily loan and spend its way out of the Great Recession by commanding banks to lend like crazy.


Even admirers, though, cannot fail to spot China's bad-debt problem. Those who think capitalist democracies have an unrivaled talent for generating dud loans should consider the Middle Kingdom.

Bad, politically motivated management in the past meant that by the late 1990s, almost a third of all loans in China were to zombie state-run enterprises, thus requiring China to lead the world in bank bailouts for most of the last decade.

The latest binge, as the newspaper calls it, is likely to trigger similar dynamics in the sense of overbuilding capacity.  Yes, the gov can afford the hit, but that's mostly because the Chinese save at such a high rate, meaning banks don't need to turn to debt markets.

Real change to the system will come, as always, with success.  The more the middle class emerges, the more banks will need to clear up space on balance sheets to loan out money to individuals and small firms, and "The heavy lifting of financing infrastructure and state companies will shift to bond markets."

In the end, China's banking system will not be all that different from the West's.

The concluding argument of the editorial:

China’s banks could then end up looking a lot like banks elsewhere, although the state will still have control. Yet even that could change gradually. At current growth rates China’s banks will need capital injections every few years. The government may tire of these shakedowns—its participation in this year’s equity raisings has been a little grudging—and allow its stake to be diluted instead. And, as China’s banks claim their rightful place among the global leaders, they will find doing big foreign deals is hard when the government has a hand on the steering wheel. The rise of China’s banks is stunning and a little frightening. Yet they are not the pallbearers of market-based finance, just a work in progress.

Beware the bullshit artists who claim China is somehow making a new model of development happen.


Slowly grind the gears at Basel

WSJ front-page headline, though now a week old. 

But the nice thing about this rule-set reset is that it drags on with all the urgency usually mounted by bankers when it comes to unpleasant change.  So it’s hard to fall behind the curve much.

The gist: large multinational banks will be forced to raise “vast sums to cushion any future losses.”

The give:  the new rules won’t go into effect for a bit.

The “race” as it is called:  to hammer out the new rules by year’s end.

The two main players are the G-20, whose financial ministers met this week in Seoul, and the usual Basel Committee on Banking Supervision.

In many ways, the new rules will simply update the old Basel package initially set up in the late 1980s.

Perhaps it will be known as Basel III (a previous revamp years ago was dubbed Basel II).  I guess these are becoming like GATT-cum-WTO trade rounds.

Always tricky stuff to negotiate, so naturally drawn out.


Learning a thing--but not two--from Kazakhstan on banking

FT column.

Call-out text states it plainly enough:

Until recently it was generally assumed that when a bank ran into problems it would either be bailed out or go spectacularly bust.

Well, unlikely Kazakhstan provides a better example:  getting the creditors to suffer the pain. They absorb all or most of the losses, keeping the bank a going concern.

Says Tett, “In America, there is every chance that the future financial reform bill will contain some features that would impose creditor losses in the future.”

The big question?  Is this discipline imposed by a central 3rd party or the courts.

Investment groups hate the notion, but Tett calls it the least bad option.

How democratic.

Meanwhile, she laments the alternative that Europe seems to be pursuing:  “a system based on ever tighter bank rules and implicit taxpayer bail-outs.”