China’s Connectivity Revolution

Stephen S. Roach

2012-01-26
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NEW HAVEN – Long the most fragmented nation on earth, China is being brought together like never before by a new connectivity. Its Internet community is expanding at hyper speed, with profound implications for the Chinese economy, to say nothing of the country’s social norms and political system. This genie cannot be stuffed back in the bottle. Once connected, there is no turning back.


The pace of transformation is breathtaking. According to Internet World Stats, the number of Internet users in China has more than tripled since 2006, soaring to 485 million in mid-2011more than three times that in 2006. Moreover, China’s rush to connectivity is far from over. As of mid-2011, only 36% of its 1.3 billion people were connectedfar short of the nearly 80% penetration rates seen in South Korea, Japan, and the United States.


Indeed, with the cost of connectivity falling sharplyChina’s mobile users are expected to surpass PC users by 2013 – and, with urbanization and per capita incomes also rising sharply, it is not unreasonable to expect China’s Internet penetration rate to cross the 50% threshold by 2015. That would be the functional equivalent of adding about three-fourths of all existing Internet users in the US.


Nor are the Chinese casual and infrequent Internet users. Consistent with what the social-network theorist Clay Shirky has dubbed a society’s penchant for unlocking the “cognitive surplusembedded in net-based activities, survey data from the China Internet Network Information Center suggest that Chinese netizens log an average of 2.6 hours per day online – a full hour longer than the average 15-49-year-old Chinese citizen spends watching television.


China’s microblogs, or social networks, where usage tends be most intense, were estimated to have approximately 270 million users as of late 2011. And there is plenty of upside. Worldwide, about 70% of all Internet users currently engage in some form of microblogging, which is the fastest-growing segment of the Internet. In China, this share is just 55%.


When it comes to analyzing China, it is always easy to get carried away with numbers – especially those driven by the country’s sheer size. But the real message here concerns the implications of connectivity, not just its scale.


A key implication is the Internet’s potential to play a significant role in the emergence of China’s consumer society – a critical structural imperative for a long-unbalanced Chinese economy. With connectivity comes a national awareness of spending habits, tastes, and brandsessential characteristics of any consumer culture.


The consumption share of China’s economy, at less than 35% of GDP, is the lowest of any major country. Surging Chinese Internet usage could well facilitate the pro-consumption initiatives of the recently enacted 12th Five-Year Plan.


The Internet could also enable freer and more open communications, upward mobility, transparent and rapid dissemination of information, and, yes, individuality. China’s leadership has been increasingly vocal in raising concerns about growing inequalities that might otherwise hinder the development of what they call a more harmonious society.” Online connectivity could be a powerful means to help China come together and achieve this goal.


Finally, there is the Internet’s potential as an instrument of political change. That is hardly an inconsequential consideration for any country in the aftermath of last year’s Arab Spring, which was facilitated in many countries (especially Tunisia and Egypt) by network-enabled mobilization.


While reform of China’s single-party state has always been viewed as an important objective in modern China – from the so-called Fifth Modernization of Wei Jinsheng in the late 1970’s to recent speeches by Premier Wen Jiabaomeaningful progress has been limited. Is this likely to change as China embraces the Internet?


China is no exception in requiring leadership, accountability, and responsiveness as conditions of political stability. Its rapidly expanding Internet community has repeatedly raised national awareness of tough local issues.
This was especially evident in the aftermath of the Sichuan earthquake of 2008, ethnic violence in Xinjiang in 2009, and the high-speed rail crash in Wenzhou in 2011.


As the Arab Spring demonstrated, the Internet can quickly transform local incidents into national flashpointsturning the new connectivity into a potential source of political instability and turmoil. But that has been the case only in countries ruled by highly unpopular autocratic regimes.


By contrast, China’s leadership is viewed with a much greater degree of public sympathy. Their quick and direct response to the recent incidents in Sichuan, Xinjiang, and Wenzhou are important cases in point. Senior Party leaders – especially Premier Wen – were quick to lead an empathetic national response that was largely effective in countering the outpouring of concern expressed on the Internet.


None of this is to deny the dark side of the Chinese Internet explosion – namely, widespread censorship and constraints on individual freedom of expression. China’s SkyNet team (rumored to be greater than 30,000) is the largest cyber police force in the world.


Moreover, while China is not alone in censoring the Internet, self-policing by many of the nation’s largest portals amplifies official oversight and surveillance. Recent restrictions on microbloggers – especially denial of access to those who use untraceable aliases – have heightened concerns over Chinese Internet freedom. Such restrictions, of course, cut both ways – potentially limiting personal expression, but also constraining disguised and reckless vigilante attacks.


Filtered or not, a long-fragmented China now has a viable and rapidly expanding network. The power of that network – especially insofar as economic, social, and political change is concerned – is hard to predict. But connectivity adds a new dimension of cohesion to modern China. That can only accelerate the speed of its extraordinary development journey.


Stephen S. Roach, a member of the faculty at Yale University, is Non-Executive Chairman of Morgan Stanley Asia and the author of The Next Asia.

Copyright: Project Syndicate, 2012.



The Fed experiments with imperfect tools

Mohamed El-Erian

January 26, 2012



Policy experimentation continues unabated in the US with the Federal Reserve launching on Wednesday a new initiative to influence market valuations and, through this, the outlook for the country’s economy. The Fed hopes to use greater transparency to mould expectations in a manner that promotes economic growth and price stability. But this new approach could also create confusion and even greater hesitancy on the part of healthy balance sheets to engage in productive investments.




I suspect the Fed recognises that the policies at its disposal are a long way from ideal. Interest rates are already floored at zero and, according to the latest statement, will likely stay there at least through the end of 2014. Meanwhile, its balance sheet has ballooned to a previously-unthinkable 20 per cent of gross domestic product ($3,000bn) through direct purchases of securities in the market place. It is also “twisting”, as holdings of shorter maturity Treasuries are replaced by longer-dated ones.



This unusual policy activism has helped prevent a damaging deflationary spiral. But it has not been sufficient to restore America on the path of sustainable growth and sufficient job creation, nor will it. As acknowledged by Ben Bernanke, the Fed chairman, the benefits have come with “costs and risks”.



Moreover, despite its repeated pleas for fiscal and housing engagement, the Fed has inadvertently provided cover for other government agencies to continue avoiding difficult, but necessary, decisions.
Notwithstanding these shortfalls, the Fed still feels compelled to do even more. For both moral and political reasons, it believes that it cannot be seen to stand on the sideline as the economy struggles with a deeply-entrenched unemployment crisis and political dysfunctionality – even if this means having to use even more imperfect, indirect and, increasingly, unpredictable policy measures.



On Wednesday, the Fed showed how it intends to usecommunication” as a much more active tool to inform and influence economic outcomes. But this approach goes well beyond the concept of greater transparency. By publishing members’ individual forecasts – specifically, the annual evolution of the policy rate, the timing of the first hike and a long-term natural rate – the Federal Open Market Committee wants to provide a firmer and steadier outlook to encourage investors, in both physical and financial assets, to commit to long-term decisions.



Few expect this new initiative to have an immediate or durable impact. Beyond 2012, individual FOMC members’ forecasts are quite dispersed, including a 0.25 per cent to 2.75 per cent range for the target Federal Funds rate for end 2014. It will also take time for households, companies and investors to digest yet another set of signals. Moreover, they are much more interested in the likelihood of a new round of Fed purchases, QE3, than forecasts that deal with an unusually uncertain future and are likely to change frequently.



This latest Fed initiative would need to meet two conditions to be effective in the longer-term. We need to see a significant clustering of FOMC member forecasts that could credibly translate into a medium-term vision for policy rates, and greater responsiveness on the part of households, companies and investors to price movements. But even these will not prove sufficient unless the Fed’s continued activism is part of a more comprehensive policy response out of Washington. As yet, there is little to suggest that we are moving quickly enough to meet this requirement.



The writer is the chief executive and co-chief investment officer of Pimco



How to pull Italy and Spain back from the edge

George Soros

January 25, 2012


The longer-term refinancing operations launched by the European Central Bank in December have relieved the liquidity problems of European banks, but not the financing disadvantage of the highly indebted member states. Since high-risk premiums on government bonds endanger banks’ capital adequacy, half a solution is not enough. It leaves half the eurozone relegated to the status of developing countries that became highly indebted in a foreign currency. Instead of the International Monetary Fund, Germany is acting as the taskmaster imposing fiscal discipline. This will generate tensions that could destroy the European Union.



I have proposed a plan, inspired by Tomasso Padoa-Schioppa, the Italian central banker, that would allow Italy and Spain to refinance their debt by issuing treasury bills at about 1 per cent. It is complicated, but legally and technically sound.



The authorities rejected my plan in favour of the LTRO. The difference between the two schemes is that mine would provide instant relief to Italy and Spain, while the LTRO allows Italian and Spanish banks to engage in a very profitable and practically riskless arbitrage but has kept government bonds hovering on the edge of a precipice – though the last few days brought some relief.



My proposal is to use the European Financial Stability Facility and the European Stability Mechanism to insure the ECB against the solvency risk on any newly issued Italian or Spanish treasury bills they may buy from commercial banks. This would allow the European Banking Authority to treat the T-bills as the equivalent of cash, since they could be sold to the ECB at any time. Banks would then find it advantageous to hold their surplus liquidity in the form of T-bills as long as these bills yielded more than bank deposits held at the ECB. Italy and Spain would then be able to refinance their debt at close to the deposit rate of the ECB, which is currently 1 per cent on mandatory reserves and 25 basis points on excess reserve accounts. This would greatly improve the sustainability of their debt. Italy, for instance, would see its average cost of borrowing decline rather than increase from the current 4.3 per cent. Confidence would gradually return, yields on outstanding bonds would decline, banks would no longer be penalised for owning Italian government bonds and Italy would regain market access at more reasonable interest rates.



One obvious objection is that this would reduce the average maturity of Italian and Spanish debt. I argue that, on the contrary, this would be an advantage in current exceptional circumstances, because it would keep governments on a short leash; they could not afford to lose the ECB facility. In Italy, it would deter Silvio Berlusconi from toppling Mario Monti – if he triggered an election he would be punished by voters.



The EFSF would have practically unlimited capacity to insure T-bills because no country could default as long as the scheme is in operation. Nor could a country abuse the privilege: it would be automatically withdrawn and the country’s cost of borrowing would immediately rise.



My proposal meets both the letter and the spirit of the Lisbon Treaty. The task of the ECB is to provide liquidity to the banks, while the EFSF and ESM are designed to absorb solvency risk.


The ECB would not be facilitating additional borrowing by member countries; it would merely allow them to refinance their debt at a lower cost. Together, the ECB and the EFSF could do what the ECB cannot do on its own: act as a lender of last resort. This would bring temporary relief from a fatal flaw in the design of the euro until member countries can devise a lasting solution.



For the first time in this crisis, the European authorities would undertake an operation with more than sufficient resources. That would come as a positive surprise to the markets and reverse their mood – and markets do have moods; that is what the authorities have to learn.



Contrary to the current discourse, the long-term solution must provide a stimulus to get Europe out of a deflationary vicious circle: structural reform alone will not do it. The stimulus must come from the EU because individual countries will be under strict fiscal discipline. It will have to be guaranteed jointly and severally – and that means eurobonds in one guise or another.



The writer is chairman of Soros Fund Management. His latest book is ‘Coming Soon: Financial Turmoil in Europe and the United States’


New Year, Same Crisis

George Soros

2012-01-25
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DAVOS – The measures introduced by the European Central Bank last December, especially the Long Term Refinancing Operation (LTRO), have relieved the liquidity problems of European banks, but have not cured the financing disadvantage of the highly indebted member states. Since high-risk premiums on government bonds endanger the capital adequacy of banks, half a solution is not enough.



Indeed, that supposed solution leaves half the eurozone relegated to the status of Third World countries that have become highly indebted in a foreign currency. Instead of the International Monetary Fund, it is Germany that is acting as the taskmaster imposing tough fiscal discipline on them. This will generate both economic and political tensions that could destroy the European Union.



I have proposed a plan that would allow Italy and Spain to refinance their debt by issuing treasury bills at around 1%. I named it in memory of my friend Tomasso Padoa-Schioppa, who, as Italy’s central banker in the 1990’s, helped to stabilize that country’s finances.


The plan is rather complicated, but it is legally and technically sound. I describe it in detail in my new book Financial Turmoil in Europe and the United States.



European authorities rejected my plan in favor of the LTRO. The difference between the two schemes is that mine would provide instant relief to Italy and Spain. By contrast, the LTRO allows Italian and Spanish banks to engage in a very profitable and practically riskless arbitrage, but has kept government bonds hovering on the edge of a precipice – although the last few days brought some relief.



My proposal is to use the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM) to insure the European Central Bank against the solvency risk on any newly issued Italian or Spanish treasury bills that it may buy from commercial banks. This would allow the European Banking Authority to treat these various T-bills as the equivalent of cash, because they could be sold to the ECB at any time.



Banks would then find it advantageous to hold their surplus liquidity in the form of T-bills as long as these bills yielded more than bank deposits held at the ECB. Italy and Spain would then be able to refinance their debt at close to the ECB’s deposit rate, which is currently 1% on mandatory reserves and 25 basis points on excess-reserve accounts.



This would greatly improve the sustainability of these countries’ debt. Italy, for instance, would see its average borrowing cost decline from the current 4.3%. Confidence would gradually return, yields on outstanding bonds would decline, banks would no longer be penalized for owning Italian government bonds, and Italy would gradually regain access to the market at more reasonable interest rates.



One obvious objection to this strategy is that it would reduce the average maturity of Italian and Spanish debt. I believe that, on the contrary, this would be an advantage in the current exceptional circumstances, because it would keep the Italian and Spanish governments on a short leash; no country concerned could afford to lose the ECB facility.



In the case of Italy, the short leash would dissuade former Prime Minister Silvio Berlusconi from seeking to topple Mario Monti’s new government (which has only a fragile majority), because if Berlusconi precipitated an election, the electorate would punish him. This would help to reestablish political stability and accelerate Italy’s return to the market.



My proposal fulfills both the letter and the spirit of Article 123 of the Lisbon Treaty. The ECB’s task is to provide liquidity to banks, while the EFSF and ESM are designed to absorb solvency risk. The ECB would not be facilitating additional borrowing by member countries; it would merely allow them to refinance their debt at a lower cost.



Together, the ECB and the EFSF could do what the ECB cannot do on its own. This would provide temporary relief from a fatal flaw in the euro design’s until the member countries devise a more permanent solution.



The EFSF would have practically unlimited capacity to insure eurozone T-bills in this way, because no country could default as long as the scheme was in operation. Nor could a country abuse the privilege, lest it be automatically withdrawn, causing the country’s cost of borrowing to rise immediately.



For the first time in this crisis, the European authorities would undertake an operation for which they have more than sufficient resources. Coming as a positive surprise to the markets, it would reverse their mood. After all, markets do have moods; indeed, that is what the authorities have to learn in order to deal with financial crises.



Contrary to the current discourse, the long-term solution must provide a stimulus to get Europe out of a deflationary vicious circlestructural reform alone will not do it. The stimulus must come from the EU, because individual countries will be under strict fiscal discipline. It will have to be guaranteed jointly and severally – and that means eurobonds in one guise or another.



George Soros is Chairman of Soros Fund Management and of the Open Society Institute.


Copyright: Project Syndicate, 2012.


HEARD ON THE STREET

JANUARY 26, 2012, 3:21 P.M. ET

Banks' Zero-Tolerance Tested by Fed

By DAVID REILLY




Just wait until rates rise. That has been the refrain for some time from a host of financial firms groaning under the weight of zero interest rates. Now, with the Federal Reserve saying rates may stay near zero until late 2014, those firms look like Linus waiting in vain for the Great Pumpkin.


And there is a cost to this so-far-fruitless vigil. The Fed's zero-interest-rate policy, which began in December 2008, coupled with its extraordinary moves to bring down long-term rates, have pressured profits at big banks. Meanwhile, insurers, pension funds, assets managers and others are seeing investment returns and income crimped.


Of course, dealing with interest-rate cycles is part of the financial business. But this time is quite different. If the Fed finally raises rates by late 2014, its zero-rate policy will have lasted six years.


That raises fears that financial firms are facing a structural change in the rate environment, despite the Fed's projection that short-term rates should one day bounce back to around 4%. This could lead to further cost cutting and shedding of some business lines, even as financial firms grapple with upheaval caused by the changing regulatory landscape.



There is the additional risk that the Fed's outlook could be flawed and that it has to raise rates earlier than expected. In that case, finance executives who make changes based on the Fed could actually end up wrong-footed by the central bank.



A prolonged period of ultralow rates hurt because asset returns fall but, over time, firms get less benefit from lower funding costsdeposit rates generally don't fall below zero. One clue to the cost comes from estimates banks provide on the potential impact of a sudden change in rates. In the third quarter, for example, J.P. Morgan Chase said that a one percentage point rise in all interest rates would boost pretax earnings over a 12-month period by about $2.5 billion. A rate move twice that size would result in a benefit of $4.5 billion.



Even if only long rates moved by one percentage point, while short-term ones stayed unchanged, the bank said there would be a gain of $576 million. Bank of America tells a similar tale. It said a one-percentage-point increase in rates would boost interest income by $1.4 billion.



The reason behind such gains: Banks are often able to increase the price of loans faster than they have to increase their cost of funding for, say, deposits. They are also able to roll maturing investments into higher-yielding instruments. And rising rates usually come with stronger economic growth, which leads to more lending and less bad debts.



Granted, net interest margins for banks with more than $1 billion in assets, at 3.47% at the end of the third quarter, are in line with the long-term historical average. Also, the difference, or spread, between two-year and 10-year government debt is above long-term averages.



Yet the biggest banks face a tougher time. BofA's margin in the third quarter, for example, was 2.45%. This is largely because they have a higher proportion of assets in investments, as opposed to loans, than smaller banks.


These are often of shorter-than-usual durations due to uncertainties over the rate, economic and market outlook. And that is painful: The spread between three-month and three-year government debt is about 0.34 percentage point, a third of its long-term average.



Speaking on his firm's earnings call this month, BofA finance chief Bruce Thompson said the only things that will cause net interest income to rise "are primarily a change in interest rates, and to the extent that we see a meaningful change in loan demand."



Bank investors should hold on to their comfort blankets: They face a long, cold wait for the gains that will come from any upturn in rates.

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