| Fed Lending Increases Ultimate Cost of Bank Failures; 111 Banks Fed Lent Money to Failed Posted: 04 Apr 2011 10:03 PM PDT Via emergency lending mechanisms recently released data shows that 111 banks the fed tried to keep alive via emergency lending procedures ultimately failed. Please consider the New York Times article Fed Help Kept Banks Afloat, Until It Didn'tDuring the frenetic months of the financial crisis, the Federal Reserve stretched the limits of its legal authority by lending money to more than 100 banks that subsequently failed.
The loans through the so-called discount window transformed a little-used program for banks that run low on cash into a source of long-term financing for troubled institutions, some of which borrowed regularly from the Fed for more than a year.
The central bank took little risk in making the loans, protecting itself by demanding large amounts of collateral. But propping up failing banks can increase the eventual cleanup costs for the Federal Deposit Insurance Corporation because it keeps struggling banks afloat, allowing them to get even deeper in debt. It also can clog the arteries of the financial system, tying up money in banks that are no longer making new loans.
The discount window is a basic feature of the central bank's original design, intended to mitigate bank runs and other cash squeezes. But access to it historically has been limited to healthy banks with short-term problems.
Those limits moved from custom to law in 1991, when Congress formally restricted the Fed's ability to help failing banks. A Congressional investigation found that more than 300 banks that failed between 1985 and 1991 owed money to the Fed at the time of their failure. Critics said the Fed's lending had increased the cost of those failures.
The central bank was chastened for a generation but in 2007, facing a new banking crisis, the Fed once again started to broaden access to the discount window. It reduced the cost of borrowing and started offering loans for longer terms of up to 30 days.
More than one thousand banks have taken advantage. A review of federal data, including records the Fed released last week, shows that at least 111 of those banks subsequently failed. Eight owed the Fed money on the day they failed, including Washington Mutual, the largest failed bank in American history.
Charles Calomiris, a finance professor at Columbia University who has studied discount window lending during previous crises, said the Fed had not released enough information for the public to determine whether some of the recipients were propped up inappropriately and should have been allowed to fail more quickly.
Marvin Goodfriend, a professor of economics at Carnegie Mellon University, said that such lending placed the Fed in the inappropriate position of deciding the fate of individual banks, choices that he said should be made by elected officials.
"What I think is the lesson from this is that the Congress needs to clarify the boundaries of independent Fed credit policy," Professor Goodfriend said. "There should be a mechanism so that the Fed doesn't have to make these decisions on behalf of taxpayers." Boundaries are Not the ProblemThe Fed does not care about boundaries or what is legal or not. The obvious implication is mechanisms to define Fed boundaries would be futile. We need to eliminate the Fed itself. Fed Uncertainty Principle RevisitedInquiring minds and new readers are noting the Fed Uncertainty Principle, written April 3, 2008, predicted this event well before things got seriously out of hand. Uncertainty Principle Corollary Number Two: The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.
Uncertainty Principle Corollary Number Four: The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it's easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking. FDIC 's Role in the Mess
The irony in blaming the Fed for increasing the mess for the FDIC, is that the FDIC itself is fraudulent. I have made that case repetitively, most recently in Fed Releases 895 PDFs in Response to Court Order; Fed Does Not Disclose Collateral for Loans; Why Secrecy is a Problem; FDIC's Role in the MessNotice the misguided policies of the Fed and FDIC. By preventing all bank runs for decades, the Fed instilled an artificial and undeserved confidence in banks.
It would be far better to disclose banks in trouble, let them go under one at a time quickly, rather than have a gigantic systemic mess at one time.
Secrecy, in conjunction with fractional reserve lending is an exceptionally toxic brew. Overnight trust can change on a dime, system-wide, and it did.
Moreover, by keeping poor banks alive (and my poster-boy for this is Chicago-based Corus Bank for making massive amounts of construction loans to build Florida condos), more money pours into failed institutions further increasing toxic loans.
Failure of FDIC
FDIC is a part of the problem. When the government guarantees deposits, everyone believes in every bank no matter how poorly they are run or what risks those banks poses. No one has any incentive to seek a bank with good lending practices. Instead they seek a bank that pays the highest yield because it is guaranteed.
Driving deposits to banks that take the most risk is no way to run a system. Yet, that is precisely what the FDIC does, up to the FDIC limit of course.
People look at FDIC as a big success because there was no crisis for decades. Instead, we had one gigantic crisis culminate at once, hardly a fair tradeoff for periods of artificially low problems.
FDIC is Fraudulent
No only is FDIC a problem, it is outright fraudulent to guarantee deposits that cannot possibly be guaranteed in a fractional reserve Ponzi-scheme system.
For further discussion of the problems with fractional reserve lending please see Central Bank Authorized Fraud; Fractional Reserve Lending Problems Go Far Beyond "Duration Mismatch"Also see an excellent discussion on the Acting Man blog: Fractional Reserve Banking Revisited Ending the secrecy is easy. Simply abolish the Fed. However, that not the only thing that needs to happen. For a look at solutions, please consider Geithner's Blatant Lies at the G20 Meeting; Four-Pronged SolutionMike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com
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| Dear Treasury Secretary Geithner, With All Due Respect Please "Go To Hell" Posted: 04 Apr 2011 04:25 PM PDT Treasury Secretary Geithner is not happy the Republicans have held the debt ceiling hostage to budget negotiations. In response, Geithner has embarked on a fear mongering campaign via a Debt Limit Letter to Congress promising financial Armageddon if the debt ceiling is not raised. Here are a few of Geithner's fear-mongering snips from the letter: The Honorable Harry Reid
Democratic Leader
United States Senate
Washington, DC 20510
Dear Mr. Leader:
I am writing to update you on the Treasury Department's projections regarding when the statutory debt limit will be reached and to inform you about the limits of the available measures at our disposal to delay that date temporarily.
In our previous communications to Congress, we provided regular estimates of the likely time period in which the debt limit could be reached. We can now make that projection with more precision. The Treasury Department now projects that the debt limit will be reached no later than May 16, 2011.
If the debt limit is not increased by May 16, the Treasury Department has authority to take certain extraordinary measures, described in detail in the appendix, to temporarily postpone the date that the United States would otherwise default on its obligations. These actions, which have been employed during previous debt limit impasses, would be exhausted after approximately eight weeks, meaning no headroom to borrow within the limit would be available after about July 8, 2011. At that point the Treasury would have no remaining borrowing authority, and the available cash balances would be inadequate for us to operate with a sufficient margin to meet our commitments securely.
If Congress does not act by May 16, I will take all measures available to me to give Congress additional time to act and to protect the creditworthiness of the country. These measures, however, only provide a limited degree of flexibility—much less flexibility than when our deficits were smaller.
As the leaders of both parties in both houses of Congress have recognized, increasing the limit is necessary to allow the United States to meet obligations that have been previously authorized and appropriated by Congress. Increasing the limit does not increase the obligations we have as a Nation; it simply permits the Treasury to fund those obligations that Congress has already established.
If Congress failed to increase the debt limit, a broad range of government payments would have to be stopped, limited or delayed, including military salaries and retirement benefits, Social Security and Medicare payments, interest on the debt, unemployment benefits and tax refunds. This would cause severe hardship to American families and raise questions about our ability to defend our national security interests. In addition, defaulting on legal obligations of the United States would lead to sharply higher interest rates and borrowing costs, declining home values and reduced retirement savings for Americans. Default would cause a financial crisis potentially more severe than the crisis from which we are only now starting to recover.
For these reasons, default by the United States is unthinkable. This is not a new or partisan judgment; it is a conclusion that has been shared by every Secretary of the Treasury, regardless of political party, in the modern era. Identical Letters to House Speaker, OthersGeithner sent identical letters to John A. Boehner, Speaker of the House; Nancy Pelosi, House Democratic Leader; and Mitch McConnell, Senate Republican Leader. Geithner copied key budget chairmen and others in Congress. Unfortunately, No Serious Repercussions Until July 8One disappointing aspect of the the situation is nothing terrible happens until July 8. At that time I assure you, Geithner would find another 2 months or even 4 months if necessary. Unfortunately, long before July 8, I expect Republicans will cave in to Geithner's fear-mongering tactics. Not being a politician, I can say what many Republicans undoubtedly want to say but won't. Dear Treasury Secretary Geithner, "Please Go to Hell" Polite Way of Saying "Go to Hell"If Geithner really believes what he is spouting, Republican ought to take advantage. They can do so far more politely than I suggested. A politically correct "polite" response would be along these lines: Dear Treasury Secretary Geithner In the vital interest of preserving the US dollar and to restore fiscal sanity to the United States of America, we intend to reduce the budget deficit within 10 years. In the interim, we will not increase the debt limit unless and until the President and Congressional Democrats are willing to cooperate. In return for raising the debt limit, Congress must pass and the the president must sign legislation that will... - Scrap Davis Bacon and all prevailing wage laws.
- Pass national right-to-work laws
- Reduce the budget deficit by $5 trillion in 8 years
- Balance the budget in 10 years
Given the unmistakable sincerity in your assessment of the damages that may occur should Congress fail to increase the debt ceiling, we anticipate equal sincerity in your willingness to work with Republicans to balance the budget in 10 years so that Congress will not have to go through these maddening debt-ceiling exercises in years to come. We await your reply and look forward to working with the Obama administration towards solving our budget crisis. "Yes We Can" work together. To prove our sincerity, we will hike the debt ceiling. In return, all you have to do is agree to the four points above with additional limits on the amount of budget balancing that can come from tax hikes. Cordially and With Utmost Respect Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com
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| Spanish Prime Minister Drops 2012 Reelection Bid; Trichet Transforms Into Hawk; What Does it Mean for the Euro? The Dollar? Posted: 04 Apr 2011 12:15 PM PDT Spanish Prime Minister Jose Luis Rodriguez Zapatero, has decided to not seek reelection in the March 2012 election. Zapatero has been the driving force behind various austerity measures in Spain. Will Zapatero will push for even stronger austerity measures before his term expires? That seems doubtful although by dropping out, concerns he may have had regarding voter backlash would shrink. His austerity measures have been very unpopular with voters in general but investors have cheered. Conviction to Stay the Austerity Course in QuestionWill the next government have the political will to stay the austerity course? Please consider Spain's Deficit Fight Risks Setback as Zapatero Quits ElectionSpain's efforts to reduce its budget deficit and rebuild investor confidence may suffer a setback as Prime Minister Jose Luis Rodriguez Zapatero bows out of next year's election.
Zapatero, 50, said on April 2 he won't seek a third four- year term, forcing his party to select a new candidate a year before March 2012 elections. The Socialists, which are trailing the opposition in opinion polls, will hold primaries after regional and local elections on May 22, Zapatero told party members in the capital Madrid.
Investors had rewarded Zapatero's austerity package, Spain's toughest in three decades, sending the country's borrowing costs lower even as bond yields in neighboring Portugal soared to euro-era records. The currency bloc's fourth- largest economy now faces a period of political uncertainty that may disrupt measures crucial to Spain's fiscal survival.
"The politics are turning more difficult," said Stuart Thomson, a Glasgow-based fund manager at Ignis Asset Management, which oversees about $120 billion. "There has been a lot of money coming into Spain; it started to underperform on Thursday and Friday and I suspect that underperformance will continue as a result of this."
Spain is the latest in a list of euro-area countries facing political upheaval after voters in Ireland ejected the Fianna Fail government from office in the wake of a bank crisis that left it in need of an 85 billion-euro ($121 billion) bailout. In Germany, Chancellor Angela Merkel's Christian Democrats have been punished in local elections as voters balk at the prospect of funding bailouts elsewhere in Europe.
Portuguese Prime Minister Jose Socrates resigned on March 23 after failing to win support for austerity measures.
Zapatero, a Socialist who in 2005 said he slept with his union card by his bed, made a policy U-turn in May amid Greece's fiscal crisis. He cut public wages 5 percent, reduced pensions and benefits and pushed labor-market reforms that made it cheaper for companies to fire workers.
Those measures, while popular among investors, prompted the first general strike in eight years and undermined the ruling party's popularity. The highest unemployment rate in Europe, at more than 20 percent, has also eroded support for the Socialists.
The number of people registering for jobless benefits rose for a third month in March, the Labor Ministry said today. Consumer confidence in March declined to the lowest level this year, according to a separate report from Instituto de Credito Oficial.
The opposition People's Party led by Mariano Rajoy enjoys 44.1 percent voter support, compared with 28.3 percent for the Socialists, according to an April 3 El Pais poll. Poor Economy, Poor ProspectsBy resigning, Zapatero has prematurely made himself a lame duck. The odds he could win support for additional austerity measures seems slim. Regardless of what Zapatero does in the interim, the next prime minister will inherit a poor economy, and an even worse setup, especially in regards to policy Spain has no control over. ECB president Jean-Claude Trichet seems hell-bent on hiking rates and that cannot possibly help prospects for a Spanish recovery. Trichet Seen Burying Ailing Nations With Rate Rise on InflationPlease consider Trichet Seen Burying Ailing Nations With Rate Rise on InflationJean-Claude Trichet's shot against inflation may end up inflicting collateral damage on Europe's most cash-strapped economies.
Primed to raise its benchmark interest rate this week for the first time in almost three years, President Trichet's European Central Bank again faces the conundrum that its monetary policy rarely suits all 17 members of the euro area, where the kaleidoscope of growth ranges from record expansion to recession paired with a sovereign-debt crisis.
The upshot may be that the normalization of rates from a record low of 1 percent will disproportionately hurt Spain, Greece, Portugal and Ireland, while failing to nip inflation threats in Germany. Such uneven fallout risks exacerbating the two-speed European recovery and dealing further damage to the bonds of so-called peripheral nations. Credit Suisse Group AG is warning investors away from the region's stocks and banks partly because of concern the ECB is making a policy mistake.
"As the ECB continues to tighten, it increases the risk that the sovereign-debt crisis comes back," said Gavyn Davies, chairman of London-based hedge fund Fulcrum Asset Management LLP, which oversees about $1.5 billion in assets. "It will manifest itself with the troubled economies moving into slower growth rates, and the fiscal arithmetic will worsen again."
Economies from Ireland to Spain are buckling under record debt burdens and the bursting of property bubbles, even as Germany expanded 3.6 percent last year, the strongest pace in two decades. In forecasting euro-zone growth of 1.6 percent this year, the European Commission predicts expansion of 2.4 percent in Germany, three times the anticipated rate for Spain, where unemployment is 20 percent, the highest in the region.
The situation is a "precise reverse" of the period before December 2005, when the ECB last began raising rates, said Nick Kounis, head of macro research at ABN Amro Bank NV in Amsterdam. Then Germany was weak, with growth of 0.8 percent that year, while the Irish and Spanish economies expanded 6 percent and 3.6 percent.
"We were in a world where rates were much too accommodative for the periphery and much too tight for the core," Kounis said. "Now, the situation is the same, only the countries are different. It's a problem with their one-size-fits-all policy." One Size Fits GermanyI wrote a similar column on March 8, 2011: ECB's "One Size Fits Germany" PolicyTrichet Transformation Into Monetary HawkBloomberg reports Euro Has Best First Quarter as Trichet Transforms Into HawkThe euro, seen as a potential failure 10 months ago, had its strongest start to a year on record as German growth accelerates and policy makers prepare to boost interest rates.
The currency appreciated 3.5 percent through March, the most since the final three months of 2008 and the best first- quarter performance since the region's single currency began trading in 1999, according to Bloomberg Correlation-Weighted Index data. It rose from its lowest level since 2002 in January as German Chancellor Angela Merkel and French President Nicolas Sarkozy said they would do whatever is needed to support the 17- nation monetary union.
While Portuguese bonds show increasing speculation for a default and regulators said four Irish banks need to raise 24 billion euros ($34.1 billion) in capital, currency concerns have faded since last year, when former Federal Reserve Chairman Paul Volcker and billionaire investor George Soros said the union may dissolve.
"The euro is extraordinarily strong under the circumstances," said Alan Ruskin, global head of Group-of-10 foreign-exchange strategy at Deutsche Bank AG in New York. "Does it look more capable of stumbling along than it did a year ago? Yes, to the extent that the core does seem to have made a commitment to fund bailouts."
"For some countries a rate hike doesn't fit, especially for Portugal and Greece, but also partly for Spain, where there is a problem with mortgages," said Ulrich Leuchtmann, head of foreign-exchange strategy in at Commerzbank AG in Frankfurt, who expects the euro to end 2011 at $1.32 as the Fed begins to reduce its aid to the economy. "We'll have a rate hike, and this will obviously create problems."
John Taylor, chairman of New York-based FX Concepts LLC, the world's largest foreign-exchange hedge fund, predicted in January that the euro may fall below parity with the dollar this year. Now he says the current rally may not last. Taylor, whose firm oversees about $8.5 billion, profited in the first half of 2010 betting on a slide in the currency.
"I'm sounding pretty stupid; but on the other hand, I'm not ashamed and I'm sticking with it," Taylor said last week in a telephone interview. "Europe, with all the tightening that's being forced on these countries, will be in a recession by the end of the year. There's going to be a restructuring and default of the European debt."
"The market can whip you up into a frenzy where you become irrational," said David Bloom, the global head of currency strategy at HSBC Holdings Plc in London, who said in June the euro would end 2010 at $1.35. "The difference this time around is that there is a mechanism in place. The break-up premium has come out of the euro." Sympathy of the Euro BearsI sympathize with the Euro bears, after all, I have been one too. The Euro has risen in expectation .... - The European sovereign debt crisis is over
- Trichet will hike multiple times regardless of what it does to the European economy
- Trichet will hike regardless of what it will do to the PIIGS
- Spain will not need a bailout
- Ireland, Greece, Spain, and Portugal will not default
- Bernanke will start QE III
- US Congress will do nothing to solve the deficit
- Other Central banks will hike, leaving Bernanke isolated
That is a lot of ifs. I do not think Bernanke will start QE III any time soon and if he does it may be in the context of central bankers in general engaging in widespread debasement of their currencies. Certainly I do not expect Congress to solve the budget deficit. However, I do think Congress will make some progress. Is any progress priced in? Please see Government Shutdown Battle to Be Followed by Bigger Fight; GOP wants $4 Trillion in Cuts Over Next Decade; Is that Enough? for a discussion of budget battles. For now, Ireland Caves in to Trichet. In response, Nouriel Roubini said "Eventually, the back of the government will be broken." The same applies to Irish taxpayers. How long will Irish taxpayers put up with bailing out the German, French, and British banks that foolishly lent Ireland money? Moreover, it's not just the Euro that is overpriced. Chinese banks are as insolvent as they come and China is likely headed for a market-imposed slowdown. For a discussion, please see Hidden Losses and Little Reform; China May Be Slowing More Than You Think. The love affair with the Australian dollar given its property bubble that is imploding now certainly seems questionable. Look for the Australian retail sector to follow the housing market lower. If so, I suspect the next rate move by Australia's central bank will be lower, not higher. If the Reserve Bank of Australia starts cutting rates, that would be net negative for the Australian dollar. That Japan will print more in wake of its nuclear crisis seems a given. Unless Yen printing will be balanced by more Japanese tax hikes, the Yen setup is also net dollar friendly. Finally, anti-dollar sentiment is once again near record highs. Sentiment itself is not a timing mechanism as things can always get more extreme. However, a lot of things need to happen to merit increased strength in the Euro, the Yen, the Yuan, and the Australian dollar. For now, the market has other ideas, but I like the setup here for renewed dollar strength. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com
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| Hidden Losses and Little Reform; China May Be Slowing More Than You Think Posted: 04 Apr 2011 01:41 AM PDT In his latest Email review, Michael Pettis at China Financial Markets discusses financial reform (actually the lack thereof in China), as well as an observation on China's Growth. Pettis writes .... Three months ago during their 2010 Q4 conference, the PBoC said that they believed that the global economic recovery would continue in 2011, although they acknowledged a great deal of uncertainty. The PBoC also said that stabilizing the price level was their top priority, and the central bank planned to control the "main gate" of liquidity inflows and to bring credit growth to "normal" levels.
Chen Long at SWS notified me yesterday of a change in tone. In their 2011 Q1 conference earlier this week the PBoC said that the fundamental basis of the global recovery is not very solid. The central bank still acknowledges that stabilizing price levels is an important task, but they only refer to "managing liquidity efficiently".
What does this imply? I suspect it means that policymakers are becoming a little more concerned with slowing growth and a little less concerned about domestic overheating. As I argued in the past few newsletters, growth may be slowing more quickly than Beijing would like, and combined with the very volatile external environment, I suspect they are going to be cautious about too much more tightening. We will see how many more interest rate hikes and reserve requirement hikes we are likely to get in the next quarter.
Whether or not we have reached the point in China in which investment is misallocated and debt levels rising is clearly a matter for heated debate – I think we have already passed that point – but clearly we are tending in that direction.
In the last ten years the combination of socialized credit risk, very low interest rates, state-directed lending and tremendous pressure on the part of SOEs and local and municipal governments to generate employment and growth in the short term has increased the probability that the Chinese financial system may be misallocating capital on a dangerous scale.
Aside from the many studies I've cited showing that profitability in many of China's largest companies is substantially less than the value of the financing and other subsidies, and anecdotal evidence of unnecessary real estate and infrastructure projects, just imagine what would happen to banking deposits and stock prices if the government credibly removed all guarantees on loans extended by the banks, and furthermore removed interest rate controls. I suspect most investors and depositors would assume, correctly in my opinion, a surge in non-performing loans that would wipe out the banks' capital base, and so would sell their stocks and withdraw their deposits.
The fact that this is unlikely to happen is irrelevant. It just means that the losses are hidden and transferred to the state, and via the state, to households. If that is the case, then since the banking system can no longer easily identify economically viable projects and is in fact wasting money, the usefulness of the bank-as-fiscal-agent model is much reduced. We need now to have banks in China that can correctly identify economically useful projects in which to invest and limit their credit growth to those projects.
This is, I think, pretty clearly the attitude of financial regulators at the PBoC and the CBRC. They are concerned about the pace of credit growth, which would not be a problem at all if credit were going to economically viable projects. After all, I would guess that the only significant systemic risks that banks take on are credit risk and maturity mismatch, and Chinese banks don't have to worry about the latter (no bank runs).
As I see it financial reform in China really means four things, none of which have been seriously implemented:
1. Interest rates must be liberalized so that the true cost of capital is reflected in evaluating the worth of a project. All central banks intervene in interest rates, if only to smooth out seasonal and temporary volatility, but PBoC artificially sets the rates for all maturities at least 400-800 basis points too low. By keeping the cost of capital so low, it disguises the true cost to China of capital and permits investment in projects whose returns are simply not justified.
2. Corporate governance must be reformed, and this means in part a significant reduction in the number of projects whose risks are socialized. Borrowers and banks must act on economic rather than non-economic issues, and as long as risk is socialized – implicitly or explicitly – there is no need to worry about the riskiness of repayment prospects. Remember how a much milder socialization of credit risk, the so-called "Greenspan put", distorted lending and investment decisions in the US.
3. The regulatory framework must be stabilized and government intervention should become much more predictable, at least on economic grounds. Investors should be in the business of predicting what economical value will be created, not what steps the government will take next.
4. Information quality must be sharply improved – macroeconomic information as well as financial statements. It is pointless to ask investors to make decisions about the future if they have poor or systematically biased information with which to work.
To take the last point first, I would argue that the National Bureau of Statistics and the People's Bank of China have done great jobs in improving the quality of macroeconomic and financial sector data, but there still is a long way to go, especially in the quality of financial statements. In that sense, there has been some real reform of the banking and financial systems in the past decade.
On the other three matters, however, I would argue that there has been very little change at all, expect maybe some backward movement in corporate governance in the past three years. There is from time to time some talk about eventually liberalizing interest rates, but interest rates are as controlled as they have ever been (in fact real rates have declined in the past several months to seriously negative rates) and I don't think anyone expects anything to happen soon on that front.
Banks compete heavily for deposits, but they cannot compete on price, and any attempt to get around the system – for example when banks offer gifts to attract deposits – is prohibited. Many would argue that the PBoC cannot liberalize interest rates now because if they did, and rates soared as they would be expected to do, we would see a surge in bankruptcies. This is true of course, but it is equally true that the longer we wait, the more difficult it becomes for exactly that reason.
Duration Mismatch EverywherePettis describes problems at every central bank not just China. I note with interest his discussion regarding duration (maturity) mismatch that I discussed at length twice recently: Question of StabilityPettis comments "The current Chinese financial system, even more than Japan, is clearly one in which the purpose of the financial system is to act as the state's fiscal agent and in which banking stability is guaranteed by the state. It is also clearly one in which capital misallocation can become a huge problem." Certainly misallocation of capital was a huge problem in the Anglo-Saxon model as well. We saw it spades during the DotCom and Housing busts, something Pettis admits. We also saw it in Greece, Spain, Ireland, Iceland, Portugal, the Baltic states, the UK, etc. We too socialized the losses at taxpayer expense for the benefit of the wealthy. Places like Ireland, Spain and Portugal were especially hard hit. Taxpayers will continue paying a price for another decade. Also note that the "stability" provided by the FDIC in which there were almost no bank failures for decades, came at the expense of thousands of bank failures at once. Was this a good tradeoff? I think not. Allocation of Capital Over the Long TermPettis argues that in spite of the housing blowup the Anglo-Saxon banking model has done "a pretty good job in allocating capital productively over the long term". I disagree. Under the Greenspan and Bernanke Fed we have seen serial bubble after serial bubble with increasing amplitude of booms and busts. Moreover, I would question whether we have given sufficient time to say just how poorly the system has performed. Many mistakes have been massed over as households shifted from one wage earner to two and as the baby boomer cycle progressed. We are now at a state where those boomers are starting to retire and the system is not prepared for the transition. I do not think the credit bust has fully played out. Moreover, I strongly suspect the US will suffer another lost decade. Therefore, I suggest the "long-term" to which Pettis refers has not yet happened and the decades since Nixon closed the gold window provide an insufficient window to judge. Nonetheless, I would agree with Pettis that the perverted fractional reserve fiat-credit model we are in will likely be better over the long haul than any command economy. However, that does not mean the model is any good. China's Starting Point For GrowthOne advantage of starting with little infrastructure as China did decades ago, is that there is a huge supply of economically viable projects. China was able to grow without fueling inflation because the growth was backed by a solid expansion in productive assets. That is no longer the case today as evidenced by vacant apartment, vacant malls, and even vacant cities. As a result, inflation has soared. China is clearly overheating. Pettis noted his belief "that policymakers are becoming a little more concerned with slowing growth and a little less concerned about domestic overheating." I am not in a position to disagree with Pettis on that belief. However, regardless of whether Chinese officials are "a little less concerned about domestic overheating" several facts remain - Inflation is still huge problems in China whether there is lessened concern or not
- Chinese interest rates are too low
- Price for the malinvestment and unwarranted infrastructure building is yet to be paid
- China's growth is still unsustainable
- Peak oil is a limiting constraint
- China has the world's biggest property bubble and it will bust
For more on China's property bubble please see World's Biggest Property Bubble: China's Ghost Cities Revisited; 64 Million Vacant PropertiesSpeculation, Investment Scandals, Fraud, and China's Hard Landing; Miracle of Chinese High-Speed Rail will be Reduced to Dust; Peak Oil Doomsday ClockChina and commodity bulls keep repeating the China growth story. It's important to consider the other side as presented above. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com
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