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".

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)

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.

US economy 'deteriorates further'

The Fed called the prospects for near-term economic improvement "poor"

US economic conditions got worse in January and February, the Federal Reserve has said in its influential Beige Book.

The report, which is used to help determine US interest rates, also said that improvement was not expected before late 2009 or early 2010.

"The deterioration was broad-based, with only a few sectors... appearing to be exceptions," it said.

The bank said housing markets remained "in the doldrums" in most US regions.

The report, based on information collected before 23 February, will be used at the forthcoming meeting of Federal Reserve policymakers in two weeks.

'Steep declines'

"Consumer spending remained sluggish on net, although many districts noted some improvement in January and February compared with a dismal holiday spending season," the Beige Book said.

In manufacturing, reports from most areas "suggested steep declines in activity in some sectors and pronounced declines overall".

"Reports from banks and other financial institutions indicated further drops in business loan demand, a slight deterioration in credit quality for businesses and households, and continued tight credit availability," the Federal Reserve said.

It was reported last week that the US economy had shrunk at an annual rate of 6.2% in the last three months of 2008 official figures show, a far sharper fall than previously reported.

On Tuesday Federal Reserve chairman Ben Bernanke warned of stagnation if the US authorities do not move "aggressively" to stimulate the economy.

He told the Senate Budget Committee that stabilising financial markets would be crucial for economic recovery.

Economics focus Banks need more capital

Alan Greenspan says banks will need much thicker capital cushions than they had before the bust

Greenspan AssociatesAlan Greenspan was the chairman of the Federal Reserve Board from 1987 to 2006. He is now president of Greenspan Associates

GLOBAL financial intermediation is broken. That intricate and interdependent system directing the world’s saving into productive capital investment was severely weakened in August 2007. The disclosure that highly leveraged financial institutions were holding toxic securitised American subprime mortgages shocked market participants. For a year, banks struggled to respond to investor demands for larger capital cushions. But the effort fell short and in the wake of the Lehman Brothers default on September 15th 2008, the system cracked. Banks, fearful of their own solvency, all but stopped lending. Issuance of corporate bonds, commercial paper and a wide variety of other financial products largely ceased. Credit-financed economic activity was brought to a virtual standstill. The world faced a major financial crisis.

For decades, holders of the liabilities of banks in the United States had felt secure with the protection of a modest equity-capital cushion, allowing banks to lend freely. As recently as the summer of 2006, with average book capital at 10%, a federal agency noted that “more than 99% of all insured institutions met or exceeded the requirements of the highest regulatory capital standards.”

Today, fearful investors clearly require a far larger capital cushion to lend, unsecured, to any financial intermediary. When bank book capital finally adjusts to current market imperatives, it may well reach its highest levels in 75 years, at least temporarily (see chart). It is not a stretch to infer that these heightened levels will be the basis of a new regulatory system.

The three-month LIBOR/Overnight Index Swap (OIS) spread, a measure of market perceptions of potential bank insolvency and thus of extra capital needs, rose from a long-standing ten basis points in the summer of 2007 to 90 points by that autumn. Though elevated, the LIBOR/OIS spread appeared range-bound for about a year up to mid-September 2008. The Lehman default, however, drove LIBOR/OIS up markedly. It reached a riveting 364 basis points on October 10th.

The passage by Congress of the $700 billion Troubled Assets Relief Programme (TARP) on October 3rd eased, but did not erase, the post-Lehman surge in LIBOR/OIS. The spread apparently stalled in mid-November and remains worryingly high.

How much extra capital, both private and sovereign, will investors require of banks and other intermediaries to conclude that they are not at significant risk in holding financial institutions’ deposits or debt, a precondition to solving the crisis?

The insertion, last month, of $250 billion of equity into American banks through TARP (a two-percentage-point addition to capital-asset ratios) halved the post-Lehman surge of the LIBOR/OIS spread. Assuming modest further write-offs, simple linear extrapolation would suggest that another $250 billion would bring the spread back to near its pre-crisis norm. This arithmetic would imply that investors now require 14% capital rather than the 10% of mid-2006. Such linear calculations, of course, can only be very rough approximations. But recent data do suggest that, while helpful, the Treasury’s $250 billion goes only partway towards the levels required to support renewed lending.

Government credit has in effect acted as counterparty to a large segment of the financial intermediary system. But for reasons that go beyond the scope of this note, I strongly believe that the use of government credit must be temporary. What, then, will be the source of the new private capital that allows sovereign lending to be withdrawn? Eventually, the most credible source is a partial restoration of the $30 trillion of global stockmarket value wiped out this year, which would enable banks to raise the needed equity. Markets are being suppressed by a degree of fear not experienced since the early 20th century (1907 and 1932 come to mind). Human nature being what it is, we can count on a market reversal, hopefully, within six months to a year.

Though capital gains cannot finance physical investment, they can replenish balance-sheets. This can best be seen in the context of the consolidated balance-sheet of the world economy. All debt and derivative claims are offset in global accounting consolidation, but capital is not. This leaves the market value of the world’s real physical and intellectual assets reflected as capital. Obviously, higher global stock prices will enlarge the pool of equity that can facilitate the recapitalisation of financial institutions. Lower stock prices can impede the process. A higher level of equity, of course, makes it easier to issue debt.

Another critical price for the return of global financial stability is that of American homes. Those prices are likely to stabilise next year and with them the levels of home equity—the ultimate collateral for global holdings of American mortgage-backed securities, some toxic. Home-price stabilisation will help clarify the market value of financial institutions’ assets and therefore more closely equate the size of their book capital with the realities of market pricing. That should help stabilise their stock prices. The eventual partial recovery of global equities, as fear inevitably dissipates, should do the rest. Temporary public capital injections into banks would facilitate this process and arguably provide far more benefit per dollar than conventional fiscal stimulus.

Even before the market linkages among banks, other financial institutions and non-financial businesses are fully re-established, we will need to start unwinding the massive sovereign credit and guarantees put in place during the crisis, now estimated at $7 trillion. The economics of such a course are fairly clear. The politics of draining off that much credit support in a timely way is quite another matter.

Trade, exchange rates, budget balances and interest rates as of August 28

Trade, exchange rates, budget balances and interest rates

Aug 28th 2008
From The Economist print edition