China banks top the list and other links

China banks are leading the world in assets rankings just as Japanese banks did in 1988 and American and European banks did in 2007. Ahem. [Link]

China – US trade spat is the start of the cold war, says Conor Sen. I agree.

There is loan fatigue on the part of lenders and borrowers in China. That is something to watch for. That spells trouble.

China underestimated Trump and also over-read the trans-Atlantic fissures. Well, not just China made that mistake. Many did and very few are willing to admit to it and correct themselves. They are digging deeper.

David Fickling compares the OBOR infrastructure spending (or loans to other countries) with the Soviet Union’s Siberia infrastructure buildout that strained their finances.

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How much more recklessness?

Just yesterday, I wrote that the argument by Martin Sandbu that central bankers missed a trick by not being more reckless in the years following 2008 than they already were was monstrous non-sense.

See these blog posts by Jesse Felder. How can one argue, even after seeing these posts, that central bankers were not responsible for this recklessness on the part of investors? How much more reckless would investors have been, had central banks become been even more reckless?

Callous arguments such as those are simply astounding and mind-boggling.

Monstrous non-sense

Martin Sandbu, I think, outdoes himself in his latest column. He says that central banks were not loose enough in the years following the crisis as, even after the latest Trump tax cut stimulus in the US, inflation rates are not picking up and therefore, spare capacity was much higher. If only central banks had been bolder, the negative output gap would have closed much earlier!

The certitude here is indeed breathtaking. It took my breath away for a minute. I just did not know where to begin.

The simple truth is that monetary policy has been completely orthogonal to the real economy developments after the crisis. The economies of America and Europe have recovered on their own because monetary policy has been so loose for so long that such a belated recovery cannot be attributed to policy effectiveness.

It is wrong to argue that central banks had not done enough. By April 2010, the S&P 500 had nearly doubled (up 81%) from its low in February 2009. The 10-year bond yield had crashed from 4.0% to 2.0%. Everytime it threatened to rise above 4.0%, the Federal Reserve did QE2 and QE3. It did not raise rates in 2014. In 2015 and in 2016, it raised rates by 25 basis points each – 0.5% in total in two years! Mr. Sandbu thinks that they were not bold enough?!

Monetary policy operates through financial market variables. Where was the wealth effect from these reactions in bond yields and in the stock market? Nothing.

Had the Federal Reserve been more reckless, it would have sent financial assets to even greater heights but to what effect on the real economy?

It would have only widened the inequality and the angst among the middle and lower classes. Hasn’t he seen the UK Housing Affordability Index released by the Office for National Statistics for 2017?

On average, full-time workers could expect to pay around 7.8 times their annual workplace-based earnings on purchasing a home in England and Wales in 2017, a significant increase of 2.4% since 2016.

Workplace-based housing affordability significantly worsened in England between 2016 and 2017, but there were no significant changes in Wales.

Housing affordability has worsened significantly in 69 local authorities in England and Wales over the last five years, with over three-quarters of these being in London, the South East and the East.

All but five London boroughs had significant worsening of affordability since 2012.

House prices and earnings increased in all English regions and Wales, but the two regions with the largest increase in house prices (the East (10%) and the South East (6.9%)), were the two regions with the significant differences over the year. This suggests that house prices are driving the significant worsening in affordability.

The affordability ratio has more than doubled for every property type in England from 1997 to 2017. [Link]

Right after the Brexit vote, the Bank of England had taken out a pre-emptive monetary policy accommodation insurance on top of the ultra-loose monetary policy that prevailed. Yet, Mr. Sandbu thinks that policy wast not loose enough!

Given continuously worsening affordability caused by asset price increases which are a consequence of monetary policy, does he reckon with the social and economic costs of his implicit recommendation that central bankers should have been more reckless than they already were? May be, Brexit would have been forced on David Cameron than him calling for a referendum on the matter.

May be, Trump would have won with an even bigger margin or Bernie Sanders would have won the Democratic Primaries notwithstanding all the attempts to stop him from winning it.

The Chicago Fed Financial Conditions Index is hovering near the easiest despite the Federal Reserve hiking interest rates gradually since 2015 (data as of July 27, 2018 was available at the time of writing this blog post). It only shows that the normalisation is proceeding at such a glacial pace that it is hardly registering on the financial conditions.

Graeme Wheeler, then Governor of the Reserve Bank of New Zealand said this in October 2015:

Monetary policy is, however, relatively powerless to influence the decisions that determine long-run economic performance and distributional outcomes. For example, over the long run, monetary policy can do little to generate higher spending by households and firms. Even in the shorter term, monetary policy’s influence may be low in an environment where debt levels are high and where there is considerable uncertainty about economic prospects.

Monetary policy can influence risk-taking in asset markets, but this does not necessarily translate into risk taking in long term real assets – requiring the investment and entrepreneurial decisions that underpin productivity growth and hence long-run improvements in living standards. [Link]

A gentleman (Ben Carlson) had posted a comment under Martin Sandbu’s column implicitly supporting him by providing a link to his blog post.

My comments on that are as follows:

(1) The Fed’s remit is, officially, not the stock market index

(2) Earnings improvements were a functioning of low interest rates as top lines did not improve much for quite some time after 2009. Federal Reserve policy was powerless to influence aggregate demand and real economy. See Graeme Wheeler’s comments.

(3) Most ordinary people save through bank deposits. They were robbed of their incomes even as asset prices went up.

(4) Household debt has fallen but corporate and other debt have risen significantly. Overall leverage of the U.S. economy has only increased despite the crisis having been caused by leverage

(5) The improvement in household networth says nothing about its distribution. For that, check out the work (‘A lost generation’) by the Federal Reserve Bank of St. Louis on whose networth has improved. Mr. Ben Carlson’s stock market performance would not make a difference to them.

(6) If one taunts the Fed sceptics that their criticism was a reflection of ‘sour grapes’, it is equally possible that one’s approval of Fed policy is a reflection of their personal riches. Social and public welfare consequences be damned.

Resilience of human irrationality, a I wrote in my MINT column two weeks ago, is remarkably strong.

High external tariffs were effective once

I was preparing for a lecture I have been asked to give on Technology and Development to visiting scholars of Indian Economic Service at the Singapore Civil Services College tomorrow. I had made a mental note of referring to Professor Robert Allen’s work on the history of economic development. I had written on it in MINT in February 2015. Let me recall those words here:

According to him, North America and western continental Europe caught up with the British industrial revolution by adopting the following:

• Internal free market (elimination of internal tariffs)—national single market

• Stable domestic banking system

• High external tariff

• Universal education

• Infrastructure.

They did not catch up practising free trade and open capital markets. What a surprise! [Link]

High external tariff was needed to catch up with Britain which industrialised earlier. Now, President Trump is again resorting to high external tariffs. America has a stable banking system and an internal free market. Its infrastructure is in need of improvement, for sure. In other words, trade barriers were effective. They may well be effective again. Academics are finding it difficult to accept that possibility.

I saw an article by Professor Dani Rodrik in FT.  He was making two points of which I thought one was valid – that the WTO was more intrusive than that of GATT. His second point was that such intrusion did not allow for heterogenous economic models like that of China’s. I thought that the second point was problematic.

Countries are now holding China into account for its failure to honour the very commitments it made when it joined the WTO.  It signed up to it. It benefitted from it. Its breakneck export growth and foreign exchange reserves accumulation were due to its accession to WTO. Higher Foreign Direct Investment into China was also due to WTO accession.

Second, I was not sure if China’s economic model was that heterogenous. It followed Japan’s model  – export growth, undervalued currency and protected domestic markets. Post-2008, China copied the neo-Western model of economic growth – reliance on debt. I doubt if there was much that was or is heterogenous about China’s growth model.

But, on the intrusiveness of WTO (vs. GATT), Professors Joel Trachtman and Simon Lester have responded sharply to Dani Rodrik. You can see their posts here and here.

For what it is worth, Professor Rodrik should also read this Merics brief on what certain things mean in China.

Also, I am not sure many in America see the US-China trade dispute the way Professor Stiglitz sees it. I have cited in these pages from the Harvard-Harris poll of the last few months that those polled did not want a trade war but they also wanted China dealt with, firmly.  Stiglitz writes:

No country could have a more unqualified economic team than Trump’s, and a majority of Americans are not behind the trade war

He may be too harsh on the first part of his statement but he appears most certainly wrong with the second part of his statement. He should go through carefully pages 123-130 of the June 2018 Harvard-Harris poll.

If China was winning the trade war, a rare and risky outburst from a Chinese professor against President Xi Jinping would not have happened.

As of now, it does not appear that China is either winning the battle or the war. China has imposed unremunerated reserve requirements on forward transactions on Yuan and the People’s Bank of China demands ID proof for transfer of US dollars over USD1000.00 Professor Stiglitz has allowed his biases to cloud his judgment.

He should spend some time reading the detailed two-part article that the South China Morning Post on how China might have mishandled the US on the trade dispute. One can find them here and here.

Both he and Professor Rodrik would also find it useful to read the Merics China Monitor dated 18th July 2018 on China’s cosmological communism.

Read this comment too in the FT on strains showing in China.

Not too many people – even those who are ideologically ill-disposed towards Trump find it easy to side with China. For example, FT thinks that IMF would be wrong to bail out Pakistan which tantamounts to bailing out Chinese banks that lent to Pakistan to get China to build some infrastructure as part of its ‘One Belt One Road’ initiative.

Policy tweak by Bank of Japan

Andy Mukherjee has a good piece on why BoJ might need a rethink. Its unconventional monetary policy is rendered ineffective by their effect on the banks that are supposed to implement the policy by lending aggressively! Bank profitability is at risk. They can make money only by taking on more risk in distant lands. There is simply no ‘Net Interest Margin’ at such ridiculously low interest rates. American banks’ RoA is far better, as Andy writes. Why would investors prefer Japanese banks?

Read Andy Mukherjee’s column here.

The Bank of Japan (BoJ) has released its monetary policy statement and it is here. As far as I can tell, it does not address the issue/risk raised by Andy Mukherjee. If anything, it reflects a foolhardy/brave ‘no mud on my face’ attitude after falling flat with its current policies.

It has basically tried to ‘reassure’ markets that there is no tapering of bond purchases – stealth or real. It has doubled down on its current policy stance.

That, despite all these years of powerful and persistent qualitative and quantitative easing, the inflation target remains as elusive as ever:

Prices have continued to show relatively weak developments compared to the economic and employment conditions…and it is likely to take more time than expected to achieve the price stability target of  2 per cent.

It is even possible to question if the appropriate price stability target for a population with negative demographic impulses and potential growth of 0.0% is something lower than 2.0%.

Of course, as Andy points out in a private change, there appears to be two tiny but may be significant tweaks. They may be deliberately underplaying them and overplaying continuity to ‘reassure’ markets:

(1) Yields may move upward and downward to some extent mainly depending on developments in economic activity and prices.

(2) The Bank (BoJ),  …., will reduce the size of the ‘Policy Rate Balance in financial institutions’ current account balances at the Bank – to which a negative interest rate is applied – from the current level of about 10 trillion yen on average.

Third, it has also agreed to increase the purchases of of ETFs linked to Topix stock index than Nikkei 225.

On the announcement of BoJ monetary policy decision, the US dollar spiked against the Japanese yen. Some profit-taking has set in now. On a one-year basis, US dollar is trading at the upper end of the range; on  a two-year basis, the US dollar is trading at the upper end of the range; on a five year basis, in the middle of the range (95-125) and on a ten-year basis; closer to the upper end of the range (75-125). The risk is that the USDJPY trades closer to the upper end of recent ranges at all horizons.

That may draw Trump’s ire and he may direct it at the Federal Reserve for doing the right thing (even if only gradually and belatedly) because others are persisting with their wrong and non-working policies!

How to revise GDP and other links

(1) American economy is now USD20.0 trillion and change. The personal savings rate is 6.8%. It was 3.2% before revision. Just like that. Investments in Cloud technology were allegedly under-reported. India was one of the few countries or is it the only country that revised its GDP calculations and the base year from 2004-05 to 2011-12 and reported a lower number.

See for yourself:

India GDP

(2) I liked this article that appeared in Wall Street Journal – by one Donald Luskin. He now writes as to why China will lose the trade war. That is a far cry from what many thought when the trade war began. It is not over yet. But, clearly, people are revising their odds.

(3) China is issuing dollar denominated bonds in record amounts. Nine years ago, they called for the end of US dollar hegemony. [Link]

(4) Mark Mobius says that the bottom is not in for China stocks. I leave it to you to decide on how to play it. [Link]

(5) China’s old economy is back [Link]

(6) Which means leveraging is back too [Link]

(7) FT Editors think China will listen to their advice on how to conduct Belt and Road initiatives. I am just wondering how will they have written the Edit had Trump launched OBOR and it is courting the controversies that China is courting now. [Link]

(7) Covenant-lite Leveraged loans (double whammy) are now 78% of all leveraged loans. They were 29% in 2007. [Link]

(8) Support for Merkel’s German Conservative coalition has dwindled to a 12-year low. Wait and wathc happens by the time she leaves office. [Link]

(9) That is a nice headline that explains everything that is happening in the world:

Australia executive pay hits record as workers’ wages stagnate [Link]

(10) This is what will happen in that case:

Royal Mail faces shareholders’ pay revolt [Link] AND

Nex shareholders’ punchy payday protest [Link]

(11) This may be three weeks old but Malaysia is abandoning white elephant infrastructure projects. I must confess to being pleasantly surprised so far with Malaysia’s new government [Link]

(12) This article offers a good assessment of Pakistan even as it wonders if OBOR projects have pushed the country into a debt trap.

(13) Good to know that Australian Parliament has passed two sweeping foreign interference and anti-spying  Bills [Link]