domingo, marzo 31, 2013



Rebalancing the economy

Bottoms up

Consumption in China may be much higher than official statistics suggest

Mar 30th 2013

AT HONG KONG airport, a couple hold an animated discussion about whether to buy a $350 polo shirt from Hugo Boss. Their conversation, like many in luxury shops across the city, is in Mandarin, the language of mainland China, and not the local variant, Cantonese. The mainland provides a third of the airport’s visitors and many of its most avid shoppers.

In 2012, according to estimates by Jonathan Garner and Helen Qiao of Morgan Stanley, a bank, the Chinese spent over 2.3 trillion yuan ($370 billion) on domestic tourism alone. And yet China’s GDP statistics captured only a tiny part of that spending, they argue, as well as missing spending on financial services, health care and housing. As a result, official figures show private consumption languishing at around 35% of GDP.

Morgan Stanley’sbottom-upcalculations, by contrast, imply that it has grown since 2008 to almost 46% of GDP (see chart). Mr Garner and Ms Qiao draw on company reports and industry studies to fill gaps in the official data, which, they say, undercounted consumption by $1.6 trillion in 2012, more tan Australia’s entire GDP. Their calculations echo earlier studies, which also found that official statistics undercount consumption, albeit by a smaller margin.

As well as stuff bought offshore, spending online is also undercounted, the two economists argue. On a single weekend in November, Chinese consumers spent more than $3 billion on two websites, Taobao and Tmall (both part of Alibaba, an online giant), in celebration of “singles’ day”, the bachelor’s equivalent of Valentine’s day. But official statistics have failed to keep pace with changing consumer habits, Ms Qiao argues, neglecting entire categories of e-spending.

Online gaming, for example, is largely missing. Yet it amounted to 53 billion yuan ($8.5 billion) last year, according to Morgan Stanley’s tally of revenues earned by online gaming firms.

China’s statistics have long been viewed with scepticism or worse. Some economists worry that they fail to reflect reality, others that they slavishly reflect political imperatives. In 2002 Thomas Rawski of the University of Pittsburgh complained about a “tornado of deception”. Five years later Carsten Holz, then of Princeton University, said that official statistics should be taken with a “rock of salt”. When Li Keqiang, now China’s prime minister, was party chief of Liaoning province in 2007, he called the province’s output figuresman-made” and “for reference only”.

But things are not as bad as they were. China’s National Bureau of Statistics (NBS), for example, long ago stopped relying on provincial output figures to calculate national GDP. China’s economic census in 2004 gave the national statisticians a better baseline for subsequent work. In 2006 a book published by the OECD argued emphatically that China’s national accounts are inevitablywrong”, in that they are forced to plump for one of a range of plausible figures, but that they are not politically manipulated.

But the NBS does not make it easy for independent outsiders to cross-check their work. Sceptics instead look for inconsistencies between China’s growth figures and other indicators, such as power generation or cement output. To track Liaoning’s economy, Mr Li looked at rail cargo, bank lending and electricity consumption.

Inspired by his example, three economists at the Federal Reserve Bank of San Francisco have distilled an alternative national growth index from three similar items. (It is a more sophisticated version of our ownKeqiang ker-chingindex published in December 2010.) They discovered that, contrary to popular belief, China’s growth figures are in the “same ballpark” as Mr Li’s indicators.

Not every statistical distortion serves to flatter China. Indeed, some of the biggest remaining flaws in China’s statistics are politically awkward. The official figures may, for example, exaggerate the politically sensitive income gap between urbanites and rural folk by as much as 40%, according to Jinjun Xue of Nagoya University and Wenshu Gao of the Chinese Academy of Social Sciences.

The understatement of consumption also gives ammunition to China’s critics, who worry that its economy relies too heavily on unsustainable investment and lament the government’s failure to rebalance the economy. Mr Garner and Ms Qiao’s alternative calculations imply instead that rebalancing is under way. In estimating consumption’s growing role, they assume that the hidden spending is not captured elsewhere in the GDP figures. If, in fact, this extra spending is misrecorded as something else, then consumption’s share of GDP would be even bigger.

Not everyone doubts the purchasing power of China’s consumers. At Hong Kong airport, adverts tempting customers to splurge compete with official notices designed to put them off one kind of purchase in particular. Since March 1st anyone taking more than two tins of milk powder out of the territory faces up to two years in prison, an embargo designed to retain Hong Kong powder for local mothers, amid concerns on the mainland about the safety of Chinese milk powder. China’s statisticians are not the only ones suppressing consumption.

March 28, 2013, 3:47 PM

NY Fed Paper: Lift Inflation Expectations to Boost Growth

By Michael S. Derby

In times like these, a rise in inflation expectations could do the economy some good, argues research published by the Federal Reserve Bank of New York.

The paper argues that when traditional forms of monetary policy, such as cutting short-term interest rates, can go no further, central bankers can goose economic activity higher if they can convince the public the future pace of inflation is likely to rise.

The paper says that if the public thinks inflation will rise, families and companies will seek to avoid the looming higher prices by spending their money now, in turn driving up growth. Importantly, New York Fed staff economists Gauti Eggertsson and Marc Giannoni, the paper’s authors, say this option is open to the Fed only in emergency circumstances.

When short-term rates hit 0%, as they currently have, “anticipated inflation is far from neutral, with output increasing if inflation is anticipated to rise,” the central-bank economists wrote.

Contrary to the common belief that inflation is less effective at stimulating output when inflation becomes more and more anticipated, the benefits of higher anticipated inflation can be extremely large” when short-term rates can be cut no further, the paper states.

The paper suggests the Fed could manipulate expected inflation via its official inflation target, which is currently fixed at 2%.

“It may be beneficial to let the near-term inflation target move over time in a way that depends on the state of the economy,” Messrs. Eggertsson and Giannoni wrote. Output and inflation can be stabilized more effectively by raising targeted inflation in the medium run,” they wrote, as long as the change occurs relatively quickly after the shock that waylaid the economy.

The paper’s findings are sure to be controversial, both within and outside of the Fed. The research was released as part of the New York Fed’s regular publication of analysis and as such, it does not indicate the central bank is about to change its policy stance.

Fed officials have said time and time again they remain committed to keeping prices stable, even as they pursue some of the most aggressive and unorthodox stimulus policies seen in the institution’s history. Burned by high inflation, surging unemployment and stagnant growth of the 1970s, the central bankers are loathe to let price pressures rise much, for fear they will spiral out of control again.

That said, the extraordinary level of stimulus seen in recent years has created widespread fear of a huge surge in inflation. Thus far, those anxieties have not been realized. Inflation continues to hold below the Fed’s official target of 2%, and most central bankers expect that to remain the case over the next few years.

What’s more, even the most dovish officials are hesitant to argue in favor of using higher inflation to spur growth. That said, a number of central bankers have argued that their target is not a ceiling, and that prices can reach more than 2% if they are expected to ebb in relatively short order.

Central bankers have also muddied the waters when it comes to their inflation-fighting commitment. Last December the Fed announced thresholds that govern the possible timing of interest-rate increases, saying rates will stay near 0% until what is now a 7.7% unemployment rate edges down to 6.5%, so long as expected inflation stays at less than 2.5%.

For some observers, the higher price threshold suggests a reduced commitment to keep prices in line with the target. One of the strongest advocates for the threshold regime, Charles Evans of the Chicago Fed, has argued that because the Fed is undershooting its mandate to promote maximum job growth, it might have to be willing to accept a modest rise in inflation above the target as the price of dealing with the unemployment problem.

Minneapolis Fed President Narayana Kocherlakota, another supporter of aggressive Fed action, has argued that the new inflation threshold is effectively a safety valve should price pressures rise unexpectedly. He noted in a speech Wednesday that even with jobless rates well under the current mark, “we have not seen a medium-term outlook for inflation as high as 2.25% over the past 15 years.”

So far, no central bankers have said it would be a good idea to intentionally drive expectations over the Fed’s target rate as a tool to create better growth. Instead, central bankers have relied on massive bond buying programs and enhanced guidance about the future path of rates to provide stimulus when it could no longer be found from more traditional sources such as short-term rates.

March 28, 2013 7:42 pm

With Cyprus, Europe risks being too tough on banking moral hazard

Europe has long been far too tolerant of moral hazard in its banking system. But with the Cyprus plan, the pendulum may now be swinging too far in the opposite direction.

This danger was made clear when Jeroen Dijsselbloem, the Dutch president of the eurogroup of finance ministers, rocked financial markets on Monday by hinting at a new doctrine that would put the full burden of future bank restructuring on creditors and depositors rather than taxpayers. In his words, “where you take on the risks you must deal with them, and if you can’t deal with them then you shouldn’t have taken them on”.

This hardline stance echoes the memorable advice of Andrew Mellon, US Treasury secretary in the early 1930s, as reported by then President Herbert Hoover: “Liquidate labour, liquidate stocks, liquidate farmers, liquidate real estate It will purge the rottenness out of the system People will work harder, live a more moral life.”

In July 2007, the opposite position was enunciated by Jochen Sanio, then Germany’s top financial supervisor. As IKB, a medium-sized German bank, revealed massive subprime-related losses, he argued that not bailing it out would trigger “the worst financial crisis since 1931” – an intentionally frightening reference. EU countries have since then implemented the “Sanio doctrine” by scrupulously reimbursing all creditors, including junior ones, of almost all failed banks with few and rather small exceptions in Denmark, Ireland and the UK. That this consistent dismissal of moral hazard originated in a German decision is ironic in light of later events.

Then change has come, gradually. In Deauville in October 2010, Angela Merkel, German chancellor, and President Nicolas Sarkozy of France announced that holders of euro area sovereign debt could face losses, but soon afterwards Ireland was still forbidden from “burningsenior bank bondholders.

However, policy makers slowly realised that guaranteeing all bank liabilities reinforced a damagingdoom loop” between banks and sovereigns. In July last year, Mario Draghi, president of the European Central Bank, noted that “the question of burden sharing with senior bond holders is evolving at the European level”.

Spain’s bank restructurings later that year imposed losses on many subordinated creditors. Earlier this year Ireland negotiated a deal that involved a loss for some senior bank bondholders. A largely silent revolution was instilling more market discipline into the financing of Europe’s banks.

This gradual shift was welcome. But in Cyprus it accelerated out of control, all the way to fullMellon doctrine”. The island’s two biggest banks are now being liquidated, even though the process is administrative rather than judicial, with no government financial assistance. In an echo of Deauville, European leaders signalled on March 16 that deposits were no longer safe, after which the German finance minister Wolfgang Schäuble confirmed that deposit guarantees were “only as good as a state’s solvency”. This move annihilated trust in Cypriot banks and made the imposition of capital controls inevitable.

Just as the Sanio doctrine was made unsustainable by moral hazard and fiscal constraints, the Mellon doctrine is made unsustainable by the reality of systemic risktoday as in the 1930s. In fairness to Mr Dijsselbloem, he acknowledged that governments may not impose full financial discipline “in times of crisis”, but then implied that we are in no such times right now: a heroic claim. Governments have a responsibility to protect their citizens from catastrophic meltdowns. This is why a chastened US government had to bail out AIG, the insurance group, a day after letting Lehman Brothers go bankrupt.

As the US learnt the hard way, predictability is essential in such matters but also difficult to attain. Europe must now chart a path between untenable Sanio and unrealistic Mellon.

The trade-off is not only between moral hazard and systemic fragility, but also between national fiscal responsibility and European integration. The eurogroup’s new insistence that “all insured depositors in all banks will be fully protected” may or may not be seen as a form of “deposit reinsurance”, meaning that a deposit guarantee can indeed be stronger than a member state’s own solvency. But this declaration will have little impact on depositors’ behaviour unless a European backing of national deposit guarantee systems is made explicit.

Similarly, the insistence on orderly bank restructurings in an integrated market calls for a centralised process, which should be in place before the ECB conducts a comprehensive balance sheet assessment of all 150-odd banks transferred under its direct supervisory authority, a deadline now planned around mid-2014. The clock is ticking.

The writer is senior fellow at Bruegel and visiting fellow at the Peterson Institute for International Economics

Copyright The Financial Times Limited 2013.


Off target

A misguided proposal to regulate fund managers’ pay

Mar 30th 2013

POLITICIANS need a pretty good reason for interfering in the way that a business pays its employees. So what was the rationale for a European Parliament committee vote on March 21st to regulate the pay of investment managers by limiting the level of their bonuses?

Is it because the fund-management industry represents a systemic risk to the European economy, like Banks? Some might point to the collapse of Long-Term Capital Management (LTCM) in 1998, which made markets wobble for a few weeks, or to the problems that two structured-credit funds caused Bear Stearns in 2007-08. But these were examples of hedge funds, which are not covered by the proposed cap. (Their turn, along with private equity, may come.)

Even if the funds were a systemic threat the proposal would still be flawed, as an EU agreement last month to limit bankers’ bonuses shows. That will simply encourage banks to replace bonuses with higher base salaries, in turn making it harder for firms to control costs in a downturn. The best way of reducing bankers’ pay in the long run is to insist that banks hold more capital, thereby cutting returns. The higher capital ratios imposed under the Basel 3 regime do indeed seem to be bringing bonuses down.

Do bonuses need regulating because European politicians think fund managers are overpaid? If so, one remedy lies in the hands of their domestic governments, which are free to raise taxes on high earners. A better answer lies in the hands of fund managers’ clients. Fund management is not a monopoly. No one is forced to give money to an active fund manager, someone who picks stocks in an attempt to beat the market and potentially earns a high salary if he or she achieves it. Investors are at liberty to pick a passive fund, one that simply tries to track the index at much lower cost. Over the long term the evidence suggests that the average investor would be better off taking the cheaper option.

Because active managers charge higher fees, they can reward intermediaries such as financial advisers and brokers with commissions when they persuade clients to put money into their funds. The fees of passive managers are too small to share out in this way. Commissions create a conflict of interest that governments can prevent by making sure advisers are paid by clients, not by product providers. The British government did just this in its “retail distribution review”, a set of new rules on financial advisers that came into effect this year. In contrast, the European Parliament voted against banning commission payments last September.

So the proposal to regulate fund managers’ pay looks bad in principle. It looks even worse in practice. One of the parliament’s ideas is that fund managers should eat their own cooking by holding at least half of their bonuses as investments in their own funds.

However, most UCITS are not open to American investors, so many US-born fund managers would not be able to hold units in their funds. As well as being impractical, the ruling may not truly align the interest of managers and clients.

Suppose a manager runs a fund investing in smaller Vietnamese companies. An institutional investor might put only 1% of its portfolio in such a fund in the hope of high but volatile returns.

In contrast, the proposed EU rules would force a fund manager to have a large proportion of his wealth in such a vehicle. That might make the manager more cautiousholding a lot of cash, for example—thereby acting against the best interests of the client.

Luckily, there is a long way to go before this deeply flawed proposal becomes law. First the whole parliament has to approve it; after that it has to pass muster with national governments and the European Commission. Britain, which was isolated when it came to the restrictions on bankers’ bonuses, will get some support from other EU countries with big fund-management industries. But the proposal gives a sense of the mindset of many European politicians. They want to give finance a kicking and mutual-fund managers just happened to be in range.

Cyprus has finally killed myth that EMU is benign

The punishment regime imposed on Cyprus is a trick against everybody involved in this squalid saga, against the Cypriot people and the German people, against savers and creditors. All are being deceived.

By Ambrose Evans-Pritchard

7:55PM GMT 27 Mar 2013

Cypriot students shout slogans as they stand at an entrance of the presidential palace in capital Nicosia, on Tuesday, March 26, 2013.
If Cyprus tries to claw back competitiveness with an 'internal devaluation', it will drive unemployment to Greek levels (27pc) and cause the economy to contract so fast that the debt ratio explodes Photo: AP

Capital controls have shattered the monetary unity of EMU. A Cypriot euro is no longer a core euro. We wait to hear the first stories of shops across Europe refusing to accept euro notes issued by Cyprus, with a G in the serial number.

The curbs are draconian. There will be a forced rollover of debt. Cheques may not be cashed. Basic cross-border trade is severely curtailed. Credit card use abroad will be limited to €5,000 (£4,200) a month. “We wonder how such capital controls could eventually be lifted with no obvious cure of the underlying problem,” said Credit Suisse.

The complicity of EU authorities in the original plan to violate insured bank savingshalted only by the revolt of the Cypriot parliamentleaves the suspicion that they will steal anybody’s money if leaders of the creditor states think it is in their immediate interest to do so. Monetary union has become a danger to property.

One can only smile at the denunciations of Eurogroup chief Jeroen Dijsselbloem for letting slip that the Cypriot package is a template for future EMU rescues, with further haircuts for “uninsured deposit holders”.
That is not the script. Cyprus is supposed to be a special case. Yet the “Dijssel Bomb” merely confirms that the creditor powers – the people who run EMU at the moment – will impose just such a policy on the rest of Club Med if push ever comes to shove. At the same time, the German bloc is lying to its own people about the real costs of holding the euro together. The accord pretends to shield the taxpayers of EMU creditor states from future losses. By seizing €5.8bn from savings accounts, it has reduced the headline figure on the EU-IMF Troika rescue to €10bn.

This is legerdemain. They have simply switched the cost of the new credit line for Cyprus to the European Central Bank. The ECB will have to offset the slow-motion bank run in Cyprus with its Emergency Liquidity Assistance (ELA), and this is likely to be a big chunk of the remaining €68bn in deposits after what has happened over the past two weeks.

Much of this will show up on the balance sheet of the Bundesbank and its peers through the ECB’s Target2 payment nexus. The money will leak out of Cyprus unless the Troika tries to encircle the island with razor wire.

“In saving €5.8bn in bail-out money, the other euro area countries will likely be on the hook for four to five times more in contingent liabilities. But, of course, the former represents real money that gives politicians a headache; the latter is monopoly central bank money,” said Marchel Alexandrovich, from Jefferies.

Chancellor Angela Merkel will do anything before the elections in September to disguise the true cost of the EMU project. It has been clear since August 2012 that she is willing let the ECB carry out bail-outs by stealth, as the lesser of evils. Such action is invisible to the German public. It does not require a vote in the Bundestag. It circumvents democracy.

Mrs Merkel can get away with this, provided Cyprus does not leave EMU and default on the Bundesbank’s Target2 claims, yet that may well happen.

“I wouldn’t be surprised to see a 20pc fall in real GDP,” said Nobel economist Paul Krugman.

Cyprus should leave the euro. Staying in means an incredibly severe depression.”

Nobody knows what is going to happen. The economy could go into a free fall,” said Dimitris Drakopoulos, from Nomura.

The country has just lost its core industry, a banking system with assets equal to eight times GDP, and has little to replace it with. Cyprus cannot hope to claw its way back to viability with a tourist boom because EMU membership has made it shockingly expensive.

Turkey, Croatia or Egypt are all much cheaper. Manufacturing is just 7pc of GDP. The IMF says the labour cost index has risen even faster than in Greece, Spain or Italy since the late 1990s.

What saved Iceland from mass unemployment after its banks blew up – or saved Sweden and Finland in the early 1990s – was a currency devaluation that brought industries back from the dead. Iceland’s krona has fallen low enough to make it worthwhile growing tomatoes for sale in greenhouses near the Arctic Circle.

If Cyprus tries to claw back competitiveness with an “internal devaluation”, it will drive unemployment to Greek levels (27pc) and cause the economy to contract so fast that the debt ratio explodes.

The IMF’s Christine Lagarde has given her blessing to the Troika deal, claiming that the package will restore Cyprus to full health, with public debt below 100pc of GDP by 2020.

Yet the Fund has already been through this charade in Greece, and her own staff discredited the doctrine behind EMU crisis measures. It has shown that the “fiscal multiplier” is three times higher than thought for the Club Med bloc. Austerity beyond the therapeutic dose is self-defeating.

Some in Nicosia cling to the hope that Cyprus can carry on as a financial gateway for Russians and Kazakhs, as if nothing has happened. RBS says the Russians will pull what remains of their money out of Cyprus “as soon as the capital controls are lifted”.

The willingness of the Cypriot authorities last week to seize money from anybody in any bank in Cyprus – even healthy banks – was an act of state madness. We will find out over time whether this epic blunder has destroyed confidence in the country as a financial centre, or whether parts of the financial and legal services sector can rebound.

Yet surely there is no going back to the old model, even though the final package restricts the losses to the two banks that are actually in trouble. Savers above €100,000 at Laiki will lose 80pc of their money, if they get anything back. Those at the Bank of Cyprus will lose 40pc.

Thousands of small firms trying to hang on face seizure of their operating funds. One Cypriot told me that the €400,000 trading account of his father at Laiki had just been frozen, leaving him unable to pay an Egyptian firm for a consignment of shoes.

The Cyprus debacle has taught us yet again that EMU has gone off the rails, is a danger to stability, and should be dismantled before it destroys Europe’s post-War order.

Whether it marks a watershed moment in the crisis is another matter. Italy, Spain, France and Portugal have their own crises, moving to their own rhythm.

The denouement will arrive when the democracies of southern Europe conclude that recovery is a false promise and that the only way to end mass unemployment is to break free of EMU’s contractionary regime.

It will be decided by Italy, not Cyprus.