China's balancing economic acrobatics

Is China's economic stimulus too much of a good thing?

Reuters

CHINESE growth was already the envy of the world. Now recession-stricken countries will be turning an even brighter green. On Thursday July 16th new figures showed China’s GDP growth quickened to 7.9% in the year to the second quarter. That is healthy enough by anyone’s standards but the headline number conceals a more astonishing rebound. Goldman Sachs estimates that GDP grew at an annualised rate of 16.5% in the second quarter compared with the previous three months. Over the same period, America’s economy probably contracted again. China’s economic stimulus has clearly been hugely effective. So effective, indeed, that some economists are now worrying it may be working rather too well.

In the year to June fixed investment surged by 35%, car sales rose by 48%, and purchases of homes by more than 80%. After falling last year, home prices are now rising briskly in some big cities, and share prices have soared by 80% from their November low. Domestic spending has been spurred partly by the government’s stimulus package, but probably even more important was the scrapping of restrictions on bank lending late last year. In June new lending was more than four times larger than a year earlier.

One reason why the economy has rebounded so quickly is that much of the slowdown was self-inflicted, rather than the result of America’s economic collapse. In 2007 concerns about overheating prompted the government to curb the flow of credit for construction and home buying. This caused China’s economy to slow sharply even before the global financial crisis. Then, last November, the government turned the credit tap back on full.

That has given a big boost to domestic spending but raised concerns that the flood of liquidity will push up inflation, fuel bubbles in shares and housing, and store up bad loans. The M2 measure of money surged by 29% in the year to June. In fact the risk of high inflation in the near future appears low: Chinese consumer prices fell by 1.7% in the year to June, and spare capacity at home and abroad is holding down prices. But asset prices could be a bigger danger. According to one estimate, 20% of new lending went into the stockmarket in the first five months of this year.

It is probably too soon to use the word “bubble”. The stockmarket is still at only half its 2007 peak and, although house prices have risen sharply this year in Shanghai and Shenzhen, the nationwide average is barely higher than it was a year ago. But the pace of bank lending is unsustainable, and America’s recent experience suggests that it is better to prevent bubbles forming than to mop up the mess afterwards. Several officials at the central bank People’s Bank of China (PBOC) have said lending should be curbed.

At the moment, the prime minister, Wen Jiabao, is signalling that he wants monetary policy kept fairly loose. Exports remain weak and the government fears premature tightening could derail the recovery. It is also keen to create jobs and maintain social stability in the months before the 60th anniversary of Communist Party rule in October.

Still, the central bank has begun to tug gently at the reins. It has nudged up money-market interest rates and warned banks that it intends to increase its scrutiny of new bank loans. The China Banking Regulatory Commission has warned banks to stick to rules on mortgages for second homes, which require a down-payment of at least 40% of a property’s value.

The recent rebound in house sales is, in fact, exactly what the government is aiming for, since it is using property as a way to spur private consumption. Higher house sales encourage more spending on furniture and consumer appliances. Construction also creates lots of jobs; indeed, it employs almost as many workers as the export sector. Since October the government has encouraged people to buy houses by cutting the minimum mortgage down-payment on their main home from  30% to 20% and by reducing stamp duty and other taxes on property transactions. Stronger sales are now feeding through into new house building: housing starts rose by 12% in the year to June, the first growth in 12 months.

Given the importance of property to domestic demand, the government is highly unlikely to want to clamp down hard on the housing market. Despite the recent lending boom, Chinese banks’ mortgage lending is still very conservative compared with that in America—at the peak of America’s housing bubble it was easy to get a mortgage for 100% or more of the value of a home. Nevertheless, the lesson of America’s financial crisis for China’s government is plain: overly loose lending should never be ignored.

CHINA: REPLACE DOLLAR AS INTERNATIONAL FINANCIAL STANDARD

China argues to replace US dollar

The dollar has been the world's reserve currency for decades

China's central bank has reiterated its call for a new reserve currency to replace the US dollar.

The report from the People's Bank of China (PBOC) said a "super-sovereign" currency should take its place.

Central bank chief Zhou Xiaochuan has loudly led calls for the dollar to be replaced during the financial crisis.

The bank report called for more regulation of the countries that issue currencies that underpin the global financial system.

"An international monetary system dominated by a single sovereign currency has intensified the concentration of risk and the spread of the crisis," the Chinese central bank said.

The dollar fell after the report was released. The US currency dropped 1% against the euro to $1.4088, and declined 0.8% versus the British pound to $1.6848.

SDRs

Mr Zhou caused a stir earlier this year when he said the dollar could eventually be replaced as the world's main reserve currency by the Special Drawing Right (SDR), which was created as a unit of account by the IMF in 1969.

CURRENCY RESERVES Foreign currency held by a government or a central bank Used to pay foreign debt obligations or influence exchange rates The dollar is viewed as the world's reserve currency as the vast majority of reserves are held in the US currency Smaller amounts are held in euros, pounds and yen Dollar poses dilemma for China

The PBOC said in the report that not only should the world adopt the SDR, but that the IMF should be entrusted with managing a portion of its member countries' foreign currency reserves.

"To avoid intrinsic shortcomings in using a sovereign currency as a reserve currency, we need to create an international reserve currency that is divorced from sovereign states and can maintain a stable value over the long term," the PBOC report said.

It also issued some veiled criticism of the US policies, saying that one of the major issues was that it was difficult to balance the needs of domestic politics with the requirements of being the world's reserve currency.

"The economic development model of debt-based consumption is most difficult to sustain," the PBOC said.

Russian President Dmitry Medvedev recently joined Mr Zhou in saying it was time to consider an alternative benchmark currency for international debt.

But Russian finance minister Alexei Kudrin then said "it's too early to speak of an alternative".

A shortlist of the Worlds Best Banks

As the dust starts to settle, which banks deserve the most plaudits?

Illustration by S. Kambayashi

TRYING to work out which banks are the world’s best is a bit like awarding the prize for prettiest war-torn village. It is a title that carries little kudos. It is also likely to prompt further shelling. Winners of industry awards in the past three years include Ken Lewis, the chief executive of Bank of America, for banker of the year (2008); Société Générale for its risk management; and Angelo Mozilo of Countrywide, a failed mortgage lender, for a “lifetime of achievement”.

Still, the question is becoming more pertinent. After months of indiscriminate fear, widespread losses and government hand-holding, the banking industry is gradually stabilising. Money markets are steadily calming. American banks that got a clean bill of health in this month’s stress tests are queuing up to repay government money. A first wave of escapees is likely to include Goldman Sachs, Morgan Stanley and JPMorgan Chase. Those banks that emerge from this crisis with reputations and franchises strengthened will find it increasingly easy to raise funds, win clients, attract employees and buy assets.

Plenty of institutions have come through the crisis relatively unscathed. The Chinese banks now dominate rankings by market capitalisation. Standard Chartered, an emerging-markets lender, seems to be steering a deft course through the downturn in the developing world. Rabobank, a wonderfully dull co-operative bank in the Netherlands, is the only bank that can still boast a AAA rating from Standard & Poor’s. Bank of New York Mellon, a large custodian, has won lots of new business from belatedly risk-averse clients. But to win the shiniest medals, you need to have come under fire. In the heat of battle, which banks have come off best?

Working out the answer is trickier than it looks. Independence from the government is one marker of success, yet America’s largest banks were given little choice but to take government capital in October. In Europe some avoided state cash by treating existing shareholders badly: witness the money that Barclays hurriedly raised from Middle Eastern investors last year. And lowish credit-default-swap spreads on banks such as Deutsche Bank and Credit Suisse partly reflect the assurance of government help if needed.

Share prices offer another perspective. Every bank investor has been hammered in the past two years, of course, but some have done much better than others. Investors in Citigroup and Royal Bank of Scotland have been all but wiped out. Even the best performing big banks have lost a third of their value in that period. Over a longer time frame, from the start of the bubble to the present, only a handful of the big firms have delivered capital gains for their investors. They include Goldman Sachs, Credit Suisse, BNP Paribas of France and Banco Santander of Spain.

But share prices are also imperfect gauges of bank performance. During the boom investors rewarded growth, whether it was sustainable or not. Banks that avoided the stampede into credit in the go-go years grumble, with some justice, that they were punished for their conservatism. Continuing volatility in share prices partly reflects deep uncertainty over banks’ future earnings power.

The league table of industry write-downs and credit losses is another indicator. There is red ink everywhere but some have spilled much more than expected. HSBC has lost $42.2 billion to date, most of it thanks to its disastrous foray into America’s subprime-mortgage market. The bank is otherwise well run, with a conservative approach to funding that has served it well, but it has lost more to date than the likes of Royal Bank of Scotland, now largely in the hands of the state, and JPMorgan Chase, which has far more exposure to both America and investment banking. That is hard to forgive.

Success can also be judged by how well banks have positioned themselves for the future. Just surviving has been smart. The likes of Deutsche and Credit Suisse have not needed to do huge deals to produce bumper earnings in the first quarter. But many banks have splashed out during the crisis, with strikingly varied results. Bank of America’s purchase of Merrill Lynch and Lloyds TSB’s takeover of HBOS have been horror stories. Wells Fargo has done better with its purchase of Wachovia, but decent longer-term prospects cannot obscure the fact that a generous stress-test process still required it to raise more capital. BNP’s tortuous capture of Fortis gives it the euro area’s biggest deposit-taking franchise. But the dealmaking baubles go to Barclays for its cut-price acquisition of Lehman’s North American business; to JPMorgan Chase for its swoops on Bear Stearns and Washington Mutual; and to Santander for emerging from the ABN AMRO transaction, which killed off RBS and Fortis, with a big presence in Brazil at a fair price.

However the pack is shuffled, a few names keep resurfacing—in America, Goldman Sachs and JPMorgan Chase; and in Europe, Credit Suisse, Deutsche, BNP, Barclays and Santander. They can be whittled down further. In Europe, concerns over what lies on the balance-sheets of Deutsche and Barclays are ebbing but are not gone. The British bank’s willingness to consider a sale of BGI, its asset-management arm, suggests worries over capital. Both banks still have lots of legacy assets, many of them tucked in the banking book.

Santander should rightfully take its bow alongside its regulators, who closed off the capital benefits of building up big off-balance-sheet positions and required Spanish banks to put aside provisions during the upswing. BNP has played its hand very well, but its business mix (a stable home market and a focus on equity derivatives) helped massively by keeping it away from the worst blow-ups.

In America, Goldman still has legions of admirers. It has posted losses of less than $8 billion to date, a performance not nearly as bad as those of its direct peers. Its focus on risk management is a template for others to follow. But its renewed swagger should not conceal the fact that it needed to convert into a bank-holding company in order to survive the market storm—nor the questions that hang over its future earnings in a re-regulated industry.

That leaves Credit Suisse and JPMorgan Chase to take the grand prizes. Credit Suisse has had its share of mishaps during the crisis but it was quick to scale down its balance-sheet, has plotted a credible strategy for its investment bank and pulled well ahead of UBS, its main rival in wealth management. As for JPMorgan Chase, it has kept a tight rein on risk, managed capital well and acquired sensibly. None of this is much comfort for weary Swiss and American taxpayers, of course. Well-run or not, both banks present the problem of being far too important to fail. And that’s to say nothing of the curse of awards.

State of European Economies

A new pecking order

There has been a change in Europe’s balance of economic power; but don’t expect it to last for long

AFP

FOR years leaders in continental Europe have been told by the Americans, the British and even this newspaper that their economies are sclerotic, overregulated and too state-dominated, and that to prosper in true Anglo-Saxon style they need a dose of free-market reform. But the global economic meltdown has given them the satisfying triple whammy of exposing the risks in deregulation, giving the state a more important role and (best of all) laying low les Anglo-Saxons.

At the April G20 summit in London, France’s Nicolas Sarkozy and Germany’s Angela Merkel stood shoulder-to-shoulder to insist pointedly that this recession was not of their making. Ms Merkel has never been a particular fan of Wall Street. But the rhetorical lead has been grabbed by Mr Sarkozy. The man who once wanted to make Paris more like London now declares laissez-faire a broken system. Jean-Baptiste Colbert once again reigns in Paris. Rather than challenge dirigisme, the British and Americans are busy following it: Gordon Brown is ushering in new financial rules and higher taxes, and Barack Obama is suggesting that America could copy some things from France, to the consternation of his more conservative countrymen. Indeed, a new European pecking order has emerged, with statist France on top, corporatist Germany in the middle and poor old liberal Britain floored.

A cockpit of competing capitalisms

It is easy to dismiss this as political opportunism. But behind it sits a big debate not only about the direction of the European Union, the world’s biggest economic unit, but also about what sort of economy works best in the modern world. Thirty years after Thatcherism began to work its cruel magic in Britain (see article), continental Europe still tends to favour a larger state, higher taxes, heavier regulation of product and labour markets and a more generous social safety-net than freer-market sorts like the Iron Lady would tolerate. So what is the evidence for the continental model being better?

The continental countries certainly have not escaped the recession: France may be doing a bit better than the world’s other big rich economies this year, but Germany, dragged down by its exporting industries, is doing significantly worse. Yet Mr Obama is right to admit that in some ways continental Europe has coped well. Tough job-protection laws have slowed the rise in unemployment. Generous welfare states have protected those who are always the first to suffer in a downturn from an immediate sharp drop in their incomes and acted as part of the “automatic stabilisers” that expand budget deficits when consumer spending shrinks. In Britain, and to an even greater extent in America, people have felt more exposed.

The downturn has also confirmed that the continental model has some strengths. France has a comparatively efficient public sector, thanks in part to years of investment in better roads, more high-speed trains, nuclear energy and even the restoration of old cathedrals (see article). Nor is it just a matter of pumping in ever more taxpayers’ cash. By any measure France’s health system delivers better value for money than America’s costlier one. Germany has not just looked after its public finances more prudently than others; its export-driven model has forced its companies to hold down costs, making them competitive not only in Europe but also globally. By design as well as luck, much of continental Europe avoided the debt-fuelled housing bubbles that popped spectacularly in Britain and America (though Spain did not, see article).

But will it last? The strengths that have made parts of continental Europe relatively resilient in recession could quickly emerge as weaknesses in a recovery. For there is a price to pay for more security and greater job protection: a slowness to adjust and innovate that means, in the long run, less growth. The rules against firing that stave off sharp rises in unemployment may mean that fewer jobs are created in new industries. Those generous welfare states that preserve people’s incomes tend to blunt incentives to take new work. That large state, which helps to sustain demand in hard times, becomes a drag on dynamic new firms when growth resumes. The latest forecasts are that the United States and Britain could rebound from recession faster than most of continental Europe.

Individual countries have specific failings of their own. Even if it did everything else right, Germany’s overreliance on exports at the expense of consumer spending has proved a grave weakness in a downturn (see article); its banks also look weak. The rate of youth unemployment in France is over 20% and it can be twice as high in the notorious banlieues where Muslim populations are concentrated. Italy and Spain have seen sharp rises in unit labour costs and their labour-productivity growth has stalled or gone into reverse. It may not be long before the fickle Mr Sarkozy is re-reading his Adam Smith.

Not what you aim for, but how you do it

If there is to be an argument about which model is best, then this newspaper stands firmly on the side of the liberal Anglo-Saxon model—not least because it leaves more power in the hands of individuals rather than the state. But the truth is that the governments on both sides of the intellectual divide could go a long way to making their models work better, without changing their underlying beliefs.

On the continental side, there is nothing especially socially cohesive about labour laws that favour insiders over outsiders, or rules that make the costs of starting a business excessive. Even Colbert might admit that Europe’s tax burdens are too onerous today, particularly since they are likely to have to rise in the future to meet the looming cost of the continent’s rapidly ageing populations.

For the liberals, even if the cycle swings back in their direction, the financial crisis and the recession have shown up defects in the way they too implemented their model. Getting regulation right matters as much as freeing up markets; an efficient public sector may count as much as an efficient private one; public investment in transport, schools and health care, done well, can pay dividends. The pecking order may change, but pragmatism and efficiency will always count.

(May 7th 2009
From The Economist print edition)

Latin America's economies That fragile thing: a good reputation

A reformed region cannot escape recession but it can mitigate its impact

FOR much of the past two centuries Latin America has been a byword for the profligate squandering of economic promise and for financial crisis. So ingrained is this reputation that when Chile’s president recently met Britain’s prime minister and boasted of her government’s foresight in saving some of its windfall revenues during the boom years, George Osborne, the shadow chancellor of the exchequer, sneered: “Gordon Brown is getting lessons from the Latin Americans about sound public finances. You couldn’t make it up.”

Happily, Mr Osborne’s view of Latin America is outdated, or at least it now applies in only a few places. Over the past decade, most of the bigger countries in the region have greatly improved their economic policies and the government institutions that implement them. That is the main reason why Latin America was until recently a spectator in the world financial crisis. Its banks are generally conservative and well-regulated. Many countries eschewed their past habit of abusing a boom to borrow. Public finances were mostly in balance, public debt fell and the region ran a current-account surplus. Indeed Chile is one of the world’s best-managed economies by almost any yardstick, but Mexico, Brazil, Colombia, Peru and Uruguay are not all that far behind.

Sadly none of this has shielded the region from the world recession (see article). Most forecasters predict that Latin America’s output will contract this year and recover only modestly next year, so income per head will shrink. Some countries are doing worse than others. Even before the flu outbreak, Mexico had been especially hard hit, because its economy is so closely tied to that of the United States. Brazil is better placed. Argentina, Venezuela and Ecuador have spurned the prudence of their neighbours and antagonised investors. Only the uncertain prospect of Chinese aid stands between these three countries and possible financial crisis next year.

Yet overall, in contrast to its past recessions, Latin America is doing no worse than the world as a whole. In other words, it is not adding to its troubles with internal weaknesses. What’s more, its governments have been able to cushion the blow with counter-cyclical policies of the kind that the rich world has taken for granted since Keynes but which Latin America’s habitual profligacy and lack of credibility denied it in the past. So instead of having to cut spending as tax revenues fall, this time many governments have been able to increase it. Their central banks have earned sufficient credentials as inflation fighters, and many have enough reserves, to cut interest rates without prompting a dangerous weakening of the currency.

Know your limits

Still, there are limits to what governments can do to mitigate the pain. While there’s scope, by and large, for easing monetary policy, fiscal policy is more constrained. The IMF, the World Bank and the Inter-American Development Bank will plug much of the gap this year, but next year looks harder. Tax revenues will have fallen further and Latin American governments’ dodgy past records may hamper their ability to raise money in debt markets that will be heavily oversubscribed.

The priority for those governments should be to maintain their hard-won reputation for financial stability. That will mean keeping a tight rein on budgets. Some of the social gains of recent years will inevitably be lost. But governments can help the poor by focusing spending on, for instance, preventing child malnutrition, discouraging pupils from dropping out of school and beefing up health services.

There is another, harder lesson. Latin America’s recent growth owed much to the outside world, cheap money and high commodity prices. With the world economy facing (at best) several sluggish years, the region will have to look closer to home for growth, by raising its productivity. That needs a huge effort not just to improve education, but also to implement long-postponed reforms of, for instance, labour markets. Such things are never easy in Latin America, where democratic politicians face voters who have to bear the world’s widest inequalities of income. But if the region is to consolidate its still novel reputation for prudent progress and good management, they will have to be done.

(From The Economist print edition)

The Economies of latin America

A reformed region cannot escape recession but it can mitigate its impact

FOR much of the past two centuries Latin America has been a byword for the profligate squandering of economic promise and for financial crisis. So ingrained is this reputation that when Chile’s president recently met Britain’s prime minister and boasted of her government’s foresight in saving some of its windfall revenues during the boom years, George Osborne, the shadow chancellor of the exchequer, sneered: “Gordon Brown is getting lessons from the Latin Americans about sound public finances. You couldn’t make it up.”

Happily, Mr Osborne’s view of Latin America is outdated, or at least it now applies in only a few places. Over the past decade, most of the bigger countries in the region have greatly improved their economic policies and the government institutions that implement them. That is the main reason why Latin America was until recently a spectator in the world financial crisis. Its banks are generally conservative and well-regulated. Many countries eschewed their past habit of abusing a boom to borrow. Public finances were mostly in balance, public debt fell and the region ran a current-account surplus. Indeed Chile is one of the world’s best-managed economies by almost any yardstick, but Mexico, Brazil, Colombia, Peru and Uruguay are not all that far behind.

Sadly none of this has shielded the region from the world recession (see article). Most forecasters predict that Latin America’s output will contract this year and recover only modestly next year, so income per head will shrink. Some countries are doing worse than others. Even before the flu outbreak, Mexico had been especially hard hit, because its economy is so closely tied to that of the United States. Brazil is better placed. Argentina, Venezuela and Ecuador have spurned the prudence of their neighbours and antagonised investors. Only the uncertain prospect of Chinese aid stands between these three countries and possible financial crisis next year.

Yet overall, in contrast to its past recessions, Latin America is doing no worse than the world as a whole. In other words, it is not adding to its troubles with internal weaknesses. What’s more, its governments have been able to cushion the blow with counter-cyclical policies of the kind that the rich world has taken for granted since Keynes but which Latin America’s habitual profligacy and lack of credibility denied it in the past. So instead of having to cut spending as tax revenues fall, this time many governments have been able to increase it. Their central banks have earned sufficient credentials as inflation fighters, and many have enough reserves, to cut interest rates without prompting a dangerous weakening of the currency.

Know your limits

Still, there are limits to what governments can do to mitigate the pain. While there’s scope, by and large, for easing monetary policy, fiscal policy is more constrained. The IMF, the World Bank and the Inter-American Development Bank will plug much of the gap this year, but next year looks harder. Tax revenues will have fallen further and Latin American governments’ dodgy past records may hamper their ability to raise money in debt markets that will be heavily oversubscribed.

The priority for those governments should be to maintain their hard-won reputation for financial stability. That will mean keeping a tight rein on budgets. Some of the social gains of recent years will inevitably be lost. But governments can help the poor by focusing spending on, for instance, preventing child malnutrition, discouraging pupils from dropping out of school and beefing up health services.

There is another, harder lesson. Latin America’s recent growth owed much to the outside world, cheap money and high commodity prices. With the world economy facing (at best) several sluggish years, the region will have to look closer to home for growth, by raising its productivity. That needs a huge effort not just to improve education, but also to implement long-postponed reforms of, for instance, labour markets. Such things are never easy in Latin America, where democratic politicians face voters who have to bear the world’s widest inequalities of income. But if the region is to consolidate its still novel reputation for prudent progress and good management, they will have to be done.

Trade Exchange Rates Budget balances

Trade, exchange rates, budget balances and interest rates

Apr 23rd 2009
From The Economist print edition

Global downturn: In graphics

This is one of the most tumultuous times on record in the global financial markets.

TRILLION-DOLLAR BAIL-OUTS

Huge amounts of money have been committed in financial support for banks.

BILLION-DOLLAR STIMULUS PACKAGES

Governments are spending billions of dollars to kick-start economic growth. Measures include tax cuts and building projects.

VICTIMS

The financial landscape has changed dramatically, with several giants of the business world disappearing.

UK BANK BAIL-OUT PACKAGE

The UK has spent £94bn to prop up Royal Bank of Scotland, HBOS and Lloyds TSB as well as nationalised Northern Rock and parts of Bradford & Bingley.

The Treasury and the Bank of England have pledged hundreds of billions of pounds of further support for the fragile banking system.

A £250bn credit guarantee scheme announced in October is being expanded to encourage banks to lend more, with a commitment of up to £50bn.

US BANK BAIL-OUT PACKAGE

There has been an array of measures to provide support to the battered US financial system.

A $700bn scheme approved last year, known as the Troubled Asset Relief Programme, was used to help lenders like Citigroup and Bank of America as well as the automobile industry.

Major changes to the programme have been announced by the new administration, including a partnership with the private sector to buy toxic assets from banks.

ECONOMIES HIT

World economic growth is expected to slow sharply, with the UK among the hardest hit. Developing countries such as China and India should fare better.

LEGACY OF DEBT

As countries try to spend their way out of recession, debt levels are forecast to rise.

Losses from Meltdown to reach 4 Thrillion USD

The International Monetary Fund (IMF) has warned that potential losses from the credit crunch could reach $4 trillion (£2.75tn) and damage the financial system for years to come.

It says that even if urgent action is taken to clean up the banking system, the process will be "slow and painful", delaying economic recovery.

It says that banks may need $1.7 trillion in additional capital.

But it warns that political support for further bank bail-outs is waning.

WHY $4TN LOSS MATTERS The banks' huge losses have made them reluctant to lend The lack of lending has pushed the world economy into a deep recession Government budgets are strained by the cost of the bail-outs, hitting taxpayers

One year ago, the IMF estimated that total losses from the credit crunch would be $1 trillion, which has been exceeded, showing how rapidly the financial meltdown has escalated.

The IMF now says that banks are likely to lose $2.7 trillion, but other financial institutions such as insurance companies and pension funds are also now coming under strain.

And it says that emerging market economies, which will need $1.8 trillion in refinancing next year, will be hard-hit by the collapse of cross-border lending, and it predicts that there will be no net private lending at all to developing countries this year.

The report comes as the IMF and World Bank are beginning their spring meeting in Washington, after receiving a promise of $750bn in fresh funds agreed at the G20 summit.

Policy response

The IMF's latest Global Stability Report says that the banking system has not yet been stabilised, despite the billions of dollars spent by governments.

Systemic risks remain high and the adverse feedback loop between the financial system and the real economy has yet to be arrested IMF

But it warns that they may be "a real risk that governments will be reluctant to allocate enough resources to solve the problem" because the public has become "disillusioned by what it perceives as abuse of taxpayer funds".

This is the situation especially in the US, where Congress appears reluctant to allocate additional bail-out funds above the $700bn approved last autumn despite the inclusion of another $750bn in President Obama's latest budget proposal.

The US Treasury has instead proposed a private-public partnership to buy up troubled assets underwritten by loans from the Federal Reserve.

But the IMF comments that "uncertainty about political reactions may undermine the likelihood that the the private sector will constructively engage in finding orderly solution to financial stress."

Deeper recession

The IMF says that restoring the banking system so that it functions normally is likely to take several years, and this will make the recession longer and deeper than usual.

COST OF REBUILDING BANKS US banks: $275bn Eurozone banks: $725bn UK banks: $250bn Other European banks: $225bn Source: IMF, based on 6% capital/assets ratio

But it warns that if policies are unclear or not implemented forcefully and promptly, "the recovery process is even more delayed and the costs, in terms of taxpayer money and economic activity, are even greater."

It says that the worldwide recession has deepened the financial crisis.

"Systemic risks remain high and the adverse feedback loop between the financial system and the real economy has yet to be arrested, despite the wide range of policy actions and some limited improvement in market functioning.

"Further effective government action - particularly geared toward cleansing balance sheets and strengthening institutions - will be required to stabilise the global financial system and to provide the foundation for a sustainable economic recovery."

On Wednesday, the IMF will present its world economic forecast.

It is expected to be the gloomiest for 60 years, with the world falling into a global recession, and an even sharper decline in output in the rich countries.

The rise and fall of the Filthy rich

The rich under attack

Apr 2nd 2009
From The Economist print edition

Going for the bankers is tempting for politicians—and dangerous for everybody else

The Bridgeman Art Library

STONES thrown through a banker’s windows in Edinburgh, workers “bossnapping” executives in France, retrospective 90% tax rates proposed in Washington, and now a riot in London as G20 leaders arrived for their summit (see article). A sea change in social attitudes that could have profound effects on politics and the world economy is under way.

The rich are certainly not the only targets in the current populist backlash. Frightened by the downturn, people are furious with politicians, central bankers and immigrants. But a rising wave of anger is directed against the new “malefactors of great wealth”. Today’s villains are a larger and more global bunch than the handful of American robber barons Teddy Roosevelt denounced a century ago; and most of them are bankers and fund managers, rather than owners of trusts and railroads. Yet the themes are similar to those at the end of that previous gilded age: rising inequality—the top 0.1% of Americans earned 20 times the income of the bottom 90% in 1979 and 77 times in 2006—and a sense that the greedy rich have cheated decent working people of their rightful share of the pie.

Some of this cheating has been of an old familiar sort: building Ponzi schemes and bribing politicians to secure favourable deals. There are greyer areas, in which the rich hide their cash in tax havens and get tax law written to their advantage—witness the indefensible treatment of private-equity profits. But what makes the rich’s behaviour so galling for many critics is that their two greatest crimes were committed in broad daylight, as they were part of the system itself.

The two great cheats

The first charge is that the rich created a new form of heads-I-win-tails-you-lose capitalism. Traders and fund managers got huge rewards for speculating with other people’s money, but when they failed the parent company, the client and ultimately the taxpayer had to pay the bill. Monetary policy contributed to this asymmetry of risk: when markets faltered central banks usually rescued them by cutting interest rates.

The second charge is that the bankers and fund managers were not doing anything useful. Unlike the “deserving” rich entrepreneurs who set up Microsoft and Google, the “undeserving” traders and brokers just shuffled money around the system to nobody’s profit but their own. The faster the money went round, the larger the financial sector loomed in the rich countries’ economies. At its peak it contributed 41% of domestic American corporate profits, more than double the rate two decades ago. As finance grew, the banks got ever bigger—too big to fail, eventually, so when they tottered taxpayers had to prop them up. Far from epitomising capitalism, the undeserving rich undermined it: it was socialism for the wealthy.

These two charges run together, but the second has much less justification. Enormous though the cost of bailing out the banks has been, there is nothing inherently undeserving about finance; even in their flawed state, more liquid markets have brought huge benefits to the rest of the economy. The lower cost of capital has made it easier for industry to invest, innovate and protect itself against interest and exchange-rate risk. Trying to single out financiers from entrepreneurs is a fool’s errand: you will end up hurting both.

The heads-I-win charge is not entirely proven, either: some of the people who ran banks did lose when they went bust. Yet even a newspaper as inherently pro-business as this one has to admit that there was something rotten in finance: the basic capitalist bargain, under which genuine risktakers are allowed to garner huge rewards, seems a poor one if taxpayers are landed with a huge bill for it all. Hence the anger.

A time for correction and brown paper bags

Periods of excess, when inequality has grown, tend to be followed by eras of reform: Roosevelt bust the trusts and shortly afterwards Congress moved towards introducing a federal income tax. Part of the genius of capitalism is its ability to adjust to disruption from within and attacks from without.

Indeed, the system is already beginning to correct itself. As our special report this week points out, the rich are not as rich as they were: some $10 trillion, around a quarter of the wealthy’s assets, has been lost. Inequality will decline. Investment banks and hedge funds are shrinking; private-equity groups are struggling to finance takeovers. Having discovered how volatile markets can be, banks will be less keen on trading in the future. There is even a correction going on in conspicuous consumption: Net-a-porter, a pricey website, offers to deliver designer outfits to its customers in brown paper bags.

The market’s self-correction will not be enough, however. Higher taxes will eventually be inevitable, since so many governments have lurched heavily into deficit. But politicians must tread carefully. Tax rises right away would be a rotten idea, since for the moment fiscal stimulus is needed. And even when governments raise the money, they should first get rid of deductions and reverse unmeritocratic measures (such as George Bush’s repeal of America’s death tax) rather than jacking up income-tax rates to punitive levels. Squeeze the rich until the pips squeak, and the juice goes out of the economy.

As for heads-I-win capitalism, the problem of asymmetric risk should shrink, because the rule changes needed to make the financial system safer will also remove unwarranted profits. Contra-cyclical capital requirements, forcing banks to build more reserves during good times, will leave them less cash to splurge on bonuses. Many of the sweetest sources of profit sprang up in the cracks between regulatory systems; governments are now filling in these gaps. If central banks focus on asset markets when they rise as well as when they fall, they will remove much of the froth. Treat a bank that becomes too big to fail like a utility, and it will make less money.

Curbing the excesses of wealth, then, will be a side effect of regulations designed to make capitalism work better. Such measures will not provide the lyrics to revolutionary anthems, but they are going to be better than going after the wealthy. The rich are an easy target. But when you try to bash them, you usually end up punching yourself in the nose.

Coca-Cola in China :Squeezed out

China indicates the real targets of its anti-monopoly law: outsiders

AP

LAST August, after 14 years of debate, the Chinese government at last imposed what was informally referred to as its “economic constitution”, a broad anti-monopoly law for a country rife with state-imposed monopolies. In the subsequent months, people have wondered how the law would be applied, and whether it would advance China’s transformation into a market economy, or serve as an impediment to genuine competition. On Wednesday March 18th an answer emerged with the rejection of the largest outright acquisition by a foreign company, a $2.4 billion offer by Coca-Cola for China Huiyuan, the country’s largest juice company.

When the deal was announced last September, it was at a price three times Huiyuan’s valuation at the time. Since then, as global markets have collapsed, it has only become more appealing. Huiyuan is a private company and juice had previously been free of government control, so theoretically it should have been available for purchase. “It is a very unfortunate outcome in an industry that has no economic or national-security significance,” says Lester Ross of WilmerHale, a law firm, in Beijing.

The most benign interpretation of the rejection being bandied about by lawyers and bankers is that it reflects a political response to critical comments by America’s new administration—a warning, of sorts, that could dissipate quickly if the economic relationship between China and America can find a firm footing. The more dire interpretation is that even as China publicly urges other countries to commit to opening their markets to Chinese investment and trade, it is imposing yet another barrier to outsiders. Worse still, the barriers are in its domestic consumer sector, one of the rare global economic bright spots.

Adding irony to the decision, it comes just as the Chinese government is indicating that it is actively encouraging, if not forcing, consolidation and greater market concentration in a number of areas, including steel, cars and airlines, and just after it imposed a new oligopoly in telecommunications. No domestic Chinese transaction has fallen foul of the new monopoly law.

Signs that foreign companies might be the primary targets of the law began to emerge in November, when a merger between two brewers, America’s Anheuser-Busch and Belgium’s InBev, was endorsed by Chinese regulators only on the condition that the combined firm’s existing interest in several domestic breweries be frozen. In particular, Anheuser-Busch’s non-controlling 27% stake in Tsingtao, a leading Chinese brewer, was largely liquidated in January after what is presumed to be pressure from the government.

The Coca-Cola Company holds as much as half of the domestic Chinese market for carbonated beverages, but the juice business is highly fragmented. Estimates are not particularly reliable, but various accounts suggest the two companies would control more than of 20% of the juice business. In a brief statement, China’s ministry of commerce said Coke’s “dominant status” might “imperil” small competitors and force consumers to face higher prices and less choice.

After the decision was announced, investment banks were left wondering, in the words of one employee, whether “a key plank in their business had just blown up.” Coke has spent years developing its presence in China, and has invested heavily, presumably making it one of the world’s more acceptable buyers. It is also one of the few companies able to finance a big deal in today’s difficult circumstances. If Coke was not acceptable to the Chinese authorities, then who is? The rejection will inevitably be used as evidence of non-reciprocity, and the collusion between the country’s state and private sectors, by anyone opposed to China’s recent efforts to buy companies abroad.

Deepening the gloom, another new Chinese law comes into effect on May 1st, subjecting any transfer of a state-controlled asset to yet another layer of review, this time by a local commission. Theoretically this is not aimed at any particular kind of acquirer, and would not block well-conceived deals, but that, of course, was said about the monopoly law as well. The new law had not received much attention. It will now.

Optimism pushes downturn

Pessimism is the most serious cause for the global economic tsunami.

It is only with a sense of optimism, preferably accompanied by a sense of energy and laughter, that we will be able to pick ourselves up from a broken Humpty Dumpty Sir David Tang

There is an ocean of people who are now feeling so depressed that not only have they become resigned to the fact that they are in deep trouble, but they have told everybody else that they are also in deep trouble.

Pessimism has an uncanny knack of being self-fulfilling.

No wonder almost every single quoted share in the world has gone down significantly, mostly by half, if not much more.

Even the most solid companies, such as HSBC, which has no real exposure; or BP, which has significant oil reserves; or a company like Dell, which has an enormous amount of cash - the shares of these companies have traded down considerably.

That is the barometer of our general pessimism.

Big collapses

The present condition has also been a wake-up call for those who have lost sight of understanding the businesses in which they invest.

Before now, there were far too many people out there trying to profit from the shuffling of papers and commodities and derivatives and options and hedging: really sophisticated instruments - but all too clever by half.

What we all need to do is to sit down and calm down and go back to basics

It just goes to show that having all these smart theories and ingenious ideas is no substitute for a solid business sense based on the fundamentals of supply and demand, with particular reference to the efficiency of the workforce; all those basic components that people such as Warren Buffett emphasise and are often ridiculed for.

Let this depressing climate also be a reminder that if you grow big, you can collapse big. The higher you climb the harder you fall.

Think small

In this mania for globalisation, it might not necessarily be good to be absolutely massive.

Just look at some of the banks and car manufacturers - they are huge, and they are in huge trouble.

What we all need to do is to sit down and calm down and go back to basics.

And most important of all, shed our sense of pessimism.

It is only with a sense of optimism, preferably accompanied by a sense of energy and laughter, that we will be able to pick ourselves up from a broken Humpty Dumpty.

In particular, governments must immediately instigate infrastructure projects to increase employment, and they must force banks, particularly those that they have rescued, to lend to small businesses.

Without a general sense of gainful employment, from which the ordinary people at large can grow optimistic, we run a huge danger of increasing unemployment.

But we cannot be complacent.

We must stem growing unemployment and promote maximum employment.

Jobs measure feelings more accurately than the Richter scale measures earthquakes.

Sir David Tang is the Hong Kong-born, English-educated entrepreneur who founded the clothing chain Shanghai Tang

$61.7bn Loss reported by AIG

AIG reports record $61.7bn loss

Ed Liddy: 'The basic operations of AIG remain rock solid'

Insurance giant AIG has reported a loss of $61.7bn (£43bn) in the final three months of 2008 - the largest quarterly loss in corporate history.

And the firm will receive an extra $30bn from the US government as part of a revamped rescue package.

AIG has already received $150bn in financial support - the biggest bail-out by far of any US company.

Stock markets slid sharply as AIG's plight underscored fears about the health of the global financial system.

The Federal Reserve and the Treasury said that AIG posed a "systemic risk" to the global financial system.

"The potential cost to the economy and the taxpayer of government inaction would be extremely high," they said.

BAIL-OUTS RECEIVED AIG - $180bn Bank of America - $45bn Citigroup - $50bn JP Morgan Chase - $25bn Wells Fargo - $25bn Goldman Sachs - $10bn Morgan Stanley - $10bn State Street - $3bn Bank of New York Mellon - $3bn

"The additional resources will help stabilise the company, and in doing so help to stabilise the financial system."

As well as insuring households, AIG plays a key role in insuring risk for financial institutions around the world.

The news of AIG's historic loss comes as HSBC, Europe's biggest bank, seeks to raise £12.5bn ($17.7bn) to strengthen its finances following a 62% fall in annual profit.

Revamp

The revamped rescue package also involves a restructuring of AIG's operations.

It calls for the Federal Reserve to take stakes in two of AIG's international units in exchange for reducing AIG's debt.

The new measures will also effectively cut the interest payments the insurer must pay to the Federal Reserve.

The AIG financial support is about three times greater than that given to Citigroup, which has received $50bn, and Bank of America, which has received $45bn.

AIG chief executive, Ed Liddy said that the loss, while hefty, could be explained.

"Asset values on a worldwide basis are going down. When we record those declines, they go through our P&L [profit and loss account] - that's about half of our loss," he said.

"Second, when you're going through a restructuring of a company, it calls into question things like good-will and deferred tax assets... We've written down the value of some of those. That's primarily what constitutes that $62bn.

"If you look past that - admittedly that's a big ask - the basic insurance operations of AIG remain rock solid."

Fear of failure

AIG: QUICK FACTS 30 million US policy holders Operates in 130 countries Provides insurance to 100,000 companies and other entities

US officials fear that a failure of AIG would be disastrous for both the US and the global economy.

Credit rating agencies, such as Moody's, Fitch and Standard & Poor's, had been poised to cut AIG's credit ratings as a result of the record loss.

That could have forced AIG to default on its debt, which would have had a knock-on effect on all of AIG's businesses.

AIG provides insurance protection to individuals, small firms, municipalities, personal pension plans and major US listed companies.

It also insures major financial institutions against complex deals going wrong through derivative contracts such as credit default swaps - the main cause of its problems.

The company first received financial assistance from the state in September in the wake of Lehman Brother's collapse.

In the UK, AIG is best known as a sponsor of Manchester United, but the deal is due to come to an end.

It also underwrites insurance sold by a number of High Street names including Boots and Argos.

Corporate lending: Waiving or Drowning

Dec 4th 2008
From The Economist print edition

Even big firms are finding it tough to secure credit from the banks

Illustration by David Simonds

CONVENTIONAL wisdom says that it is better to be a large company than a small one when credit is tight. Bigger firms have more room for manoeuvre: they have access to more types of funding, they have more fat to cut, and they have greater bargaining power with lenders. Even so, life is getting ever more uncomfortable for the bigger beasts of the corporate jungle.

According to the Federal Reserve’s most recent lending survey, American banks are tightening terms more aggressively for bigger firms than for tiddlier ones (see chart). Lenders are more cautious than they have been at least since 1990. The story among European banks is similar. Lenders in emerging markets can be more suspicious of multinational firms than they are of locals. “We just don’t know what they’ve got on their balance-sheets back home,” says one bank boss in Africa.

Violent movements in exchange rates are causing additional headaches, says Andrew Balfour of Slaughter & May, a law firm. Calculations of financial ratios can be thrown out by wild currency movements, potentially triggering breaches of loan covenants. Companies with sterling-denominated credit lines may find that their facilities are not big enough as a result of the pound’s recent sharp fall, for instance.

It is not panic stations yet. Most firms can survive for a while with the credit tap turned off. Analysis by Moody’s, a rating agency, shows that the vast majority of highly rated companies in America and Europe have enough headroom, in the form of cash and undrawn bank facilities, to be able to survive for 12 months without needing new financing. European corporate-debt markets have seen a rare flurry of issues in the past few days by opportunistic, highly rated firms.

Governments are also working hard to prop up credit markets. The Fed’s programme to buy commercial paper, a form of short-term company debt, had acquired almost $300 billion by November 26th. Banks on both sides of the Atlantic are issuing lots of government-backed bonds, which should encourage lending.

For now, an uneasy truce exists between most companies and their lenders. Some banks made tentative attempts in the autumn to pull out of loan agreements because their cost of financing had spiked so high. But they quickly backed down. In turn, banks are doing what they can to persuade corporate treasurers not to draw down credit facilities unless they have to. But hard choices are looming.

As the economic news worsens and profits dive, more firms will be at risk of breaching covenants on standard measures such as the ratio of debt to earnings before interest, tax, depreciation and amortisation. Furthermore, a good deal of debt will fall due in the next few years: Reuters Loan Pricing Corporation, a data provider, estimates that more than $1 trillion of loans will need to be refinanced globally in each of the next three years, mainly in America and Europe.

Competition for capital is bound to increase in that time, given the coming torrent of government-debt issuance. Auditors also want to be reassured about refinancing prospects well before maturity dates so they can sign off on companies as going concerns. With little obvious benefit in waiting, many expect to see a concerted effort by companies to renegotiate funding facilities early in 2009, once the year-end squeeze is over (see article).

In the face of more requests for waivers and refinancings, banks will react selectively. “We will distinguish between companies that are temporarily in crisis and those that are not,” says Alessandro Profumo, the chief executive of UniCredit, an Italian bank.

The lucky ones will still pay a hefty price for access to credit. Not only will the costs of borrowing zoom, but terms will become much tighter. Old-fashioned provisions such as “clean-up” clauses, which require borrowers to pay their debts down to zero for a specified period every year, are creeping back into some discussions. The onus is also on borrowers to show that they are taking steps to cut costs before they come to lenders for more money. Banks want to know that you have exhausted all other avenues yourself, says Sheila Smith of Deloitte, a consultancy. Even then, facilities are likely to shrink as non-bank investors such as hedge funds drop out of loan syndicates and banks that had only extended money in the hope of ancillary business also draw back.

For those firms that find doors starting to shut on them, the prospects are grim. Despite some talk of a bigger role for private placements, this is not the best time to start forging relationships with new creditors if existing ones turn unfriendly. Many firms are going into this downturn with fewer unencumbered assets than in previous recessions, which makes it harder to secure new credit. Asset disposals, one obvious way of raising cash, are extremely hard to pull off at the moment. Nor does it help that many corporate loans have been securitised and divvied up among lots of investors, making it harder for firms to negotiate modifications.

Projections for defaults are rising fast. Bain, a consultancy, now expects as many as 140 American speculative-grade companies to default in 2010, sharply up from a forecast of 40-50 in April. Worse, firms that default are likelier to end up in full liquidation. In America, debtor-in-possession financing, which helps firms that have entered Chapter 11 bankruptcy protection to meet their cash needs while they reorganise, has dried up. “The gap between financial distress and financial disaster has become much smaller,” says John Grout of the Association of Corporate Treasurers, a British trade body. So too, it seems, has the difference between big companies and small ones

World Stock Markets Today A simple Look

World stockmarkets

Dow Jones 19 Nov 08 21:06 7997.28 -427.47 ( -5.07% )		Nasdaq 19 Nov 08 20:59 1388.98 -88.78 ( -6.01% )		New York Up - 7% Down - 93%
FTSE 100 20 Nov 08 11:21 3914.97 -90.71 ( -2.26% )		DAX 20 Nov 08 11:21 4228.27 -125.82 ( -2.89% )		NASDAQ Up - 13% Down - 87%
CAC 40 20 Nov 08 11:21 2989.76 -98.13 ( -3.18% )		Nikkei 20 Nov 08 05:59 7733.16 -520.22 ( -6.30% )		Amex Up - 0% Down - 0%

Advertisement Commodities Crude Oil 20 Nov 08 11:06 52.98 -1.12 ( -2.07% ) Gold 20 Nov 08 11:06 744.9 8.9 ( 1.21% ) NYMEX Futures Jan-2009 more Energy Light Sweet Crude Oil -1.12 -2.07% COMEX Futures Dec-2008 more Precious Metals Gold 8.9 1.21% COMEX Futures Dec-2008 more Base Metals Aluminum 0.0 0.00% ELCM Futures more Softs Robusta Coffee 9.0 0.50%

JSX Up - 12% Down - 87% London Up - 21% Down - 61% Xetra Up - 17% Down - 77% Euronext Up - 0% Down - 0% Borsa Italiana Up - 11% Down - 88%