China: The Next Phase of Reform

November 12, 2013

China: The Next Phase of Reform
A policeman stands outside the Great Hall of the People, where the Communist Party held its Third Plenary Session, on Nov. 12. (FENG LI/Getty Images)


The commitment and ability of China's leaders to follow through on new policies and to meet rising expectations will be tested as they strive to balance competing social, economic, political and security challenges. Three decades ago, China embarked on a new path, creating a framework that encouraged the country's rapid economic rise. The successes of those policies have transformed China, and the country's leadership now faces another set of strategic choices to address China's new economic and international position.

The much-anticipated Third Plenary Session of the 18th Communist Party of China Central Committee concluded Nov. 12 after four days of closed-door deliberations among top political elites. The full document containing the policy proposals will not be released for days or even a week, but the initial information suggests China's leaders are seeking more significant changes in their policies to try to stay ahead of the challenges the country faces.

According to the communique broadcast by state mouthpiece China Central Television, important policy changes include the establishment of a committee to guide the country’s comprehensive reform agenda, the establishment of an integrated National Security Committee responsible for coordinating public safety and national strategy, and the easing of the country's 33-year-old family planning policy to allow more couples to have a second child. The communique also stressed that Beijing is committed to carrying out comprehensive economic reform over the next decade in accordance with China's economic, social and political transformation.

China's Demography: 2010
China's Demography: 2025

In light of China's imminent demographic imbalance, the changes to family planning were expected. The country's massive pool of cheap labor previously underpinned its economic and social transformation, but as China prepares to transition toward a consumer-based economy, its aging population is a problem.

No details have been given on the structure of the National Security Committee. The goal was to merge different institutions in charge of diplomacy, security, military and intelligence into a coordinated agency under the authority of the president.

However, the decision -- which is far more than an institutional change -- came after a re-evaluation of China's internal and external security environment and of the country's emerging role in the international community. Beijing recognizes the need for a more delicate and coherent team to handle the country's strategic issues and pursue its national interests.

China is now at a turning point. The country's economic growth has firmly cemented Chinese businesses and national interests around the globe. It has raised the living standards, but also the expectations, of China's citizens

There is a growing sense of Chinese patriotism that exists beyond the confines of the Communist Party. The emerging educated middle class has traveled the world, has seen multiple systems in action and is taking a greater interest in local and national political decisions.

Modern forms of communication such as social media give Chinese citizens the ability to rapidly share successes and grievances across the country, to identify and single out cases of political corruption and to more actively keep the Party and leadership under scrutiny. At the same time, the expanded Chinese imports of raw materials and exports of commodities have substantially expanded China's active foreign interests, requiring a more nuanced and potentially a more activist foreign policy.

Beijing wasted no time ratcheting up public expectations over its reform agenda prior to the meeting. Proposals included financial liberalization, the restructuring of state-owned enterprises, the readjustment of fiscal structures between central and local government, steps to counter official corruption, the expansion of property taxes and pricing reform. At the same time, top leaders were busy setting expectations for a new economic transformation. This led many to believe that the meeting would bring the country to the next stage of economic prosperity and social development, like Deng Xiaoping did in the post-Cultural Revolution meeting in 1978.

Admittedly, China has moved well beyond the massive economic mismanagement and social disorder of the post-Cultural Revolution period. However, the inevitable loss of the demographic advantages that sustained the country's economic miracle, combined with the prevailing social inequality and regional disparities as well as the rising political awareness of the middle class, mean the new leadership is facing even greater challenges to preserve its legitimacy. Doing so requires a constant commitment by political leaders to respond to China's changing internal and external environments. It also requires a path toward reform that meets public expectations while overcoming anti-reform elements.

November 14, 2013 9:16 am
Treasury ownership marks wealth divide
Concentration in top 1 per cent has risen sharply

Who owns America’s ever-swelling pile of government debt? This is a question that has provoked considerable angst among US politicians recently; or at least it has in relation to national identity.

Little wonder. Half a century ago, the share of US public debt held by foreigners was less than 5 per cent; but in 2008 that ratio breached 50 per cent. And while it has since fallen back slightly (because the Federal Reserve has been gobbling up bonds) the shift in ownership is nevertheless starkalong with the new power of creditors such as China.

But there is a second important point about America’s debt that has hitherto received surprisingly little attention: the shifting nature of bond investors who hail from inside the US. In past decades, it has often been assumed that Treasury bonds were widely held by the public. Indeed, since the days of Alexander Hamilton, who founded a strong central US Treasury, many politicians have thought (or hoped) that a broad involvement in the bond marketbe that among widows, orphans, middle-class citizens or oligarchswould be a source of common civic identity and social glue.

However, Sandy Hager, a postdoctoral research fellow at the London School of Economics, has recently crunched through the historical data. This research suggests that if you look at the “publicly heldUS government bond markets (ie the parts not held by another US government agency, such as the Fed), foreign ownership of federal bonds has risen from around 5 per cent in 1970 to 55 per cent today, at the expense of US households and business.
More specifically, the ratio of the bond market held by corporations during this period has declined from around 40 per cent to 30 per cent, while for households it has fallen from around 30 per cent to almost 15 per cent.

Concentrated ownership

But what is most interesting is the picture inside the “householdcategory. Contrary to the usual assumption that government debt is widely held, Mr Hager’s data suggests ownership has become far more concentrated recently, echoing a wider concentration of wealth in the US.

Back in the 1970s, for example, the richest 1 per cent of Americansonly held 17 per cent of all the federal bonds that were in private sector hands. This was partly because during the second world war and in the immediate aftermath there was a strong attempt to distribute Treasuries widely. But since the 1980s, the proportion of debt owned by the top 1 per cent started to rise sharply, hitting 30 per cent in 2000 and 42 per cent in 2013. The last time it was this high was in 1922, when the ratio was 45 per cent.

Now, this picture may not be entirely complete. Mr Hager himself admits that the historical data are often patchy, and it could be argued that modern citizens are also indirect owners of government debt through public agencies and pension funds, in ways that do not show in the data.

But, if nothing else, this pattern gives new significance to the questions that Hamilton and other historical figures first grappled with three centuries ago: namely, is public debt a potential source of civic cohesion? Or merely a subtle way for elites to entrench their power?

Skin in the game

Mr Hager, for his part, takes the latter perspective; after all, he points out, this pattern means the richest are collecting more and more interest income, but not paying a proportionate increase in taxes.

“Over the past three decades, and especially in the context of the current crisis, the ownership of federal bonds and federal interest has become rapidly concentrated in the hands of dominant owners, the top 1 per cent of households and the 2,500 largest corporations [while] the federal income tax system has done little to progressively redistribute the federal interest income received by dominant owners,” he writes.

Public debt has come to reinforce and augment the power of those at the very top of the social hierarchy,” he adds, concluding that “[Karl] Marx’s notion of a powerfularistocracy of finance’ at the heart of the public debt is . . . a very real feature of the contemporary US political economy.”

No doubt most bond investors would disagree; the nameMarx”, after all, is taboo on dealing floors. But even if you disagree with Mr Hager’s leftwing political bent, the data certainly casts a new light on the political dynamic in the current fiscal rows.

To the wealthy elites in the US who hold government bonds, it seems self-evident that the government needs to preserve the sanctity and value of Treasuries; this group has a strong incentive to ensure this happens via fiscal reform (particularly if this entails budget cuts, rather than higher taxes.) But what is rarely debated is that millions of poor Americans have far less (or no) skin in the Treasuries game. Little wonder, then, that the fiscal debate is so polarised, and unlikely to become any less so any time soon.

Public Debt, Ownership and Power, The Political Economy of Distribution and Redistribution by Sandy Brian Hager; unpublished PhD at York University, Canada


Copyright The Financial Times Limited 2013

Deflation Is Coming (and It's Not What You Think)

By Shah Gilani, Capital Wave Strategist, Money Morning

November 14, 2013

Be careful out there.

The stock market rally that started in March 2009... The one that's taken us out of the Great Recession and to new highs... The rally that's driving sentiment indicators of people who benefit from rising financial assets directly, peripherally, or because they hope all boats rise with the market...

The rally has never been loved.

The thing is, equity markets don't need love to go twice as high from here, or three times as high in the next 20 years. If they get what else they need, they'll keep going higher.

We could be on the verge of a generational bull market. That's if deficit-plagued, interconnected global sovereigns deleverage and, at the same time, re-capitalize middle and rising classes by making "recourse-sound" capital available and simultaneously reconstituting entirely the notion of taxation.

Too bad the likelihood of that happening is somewhere between slim and none.

That's one reason why I'm an increasingly reluctant bull.

But there's another reason too.

And it has to do with deflation...

The other reason I'm increasingly reluctant is because governments have been running their printing presses nonstop.

What will happen if they don't stop? What will happen if they do stop?

Besides printing on account of deflationary fears, printing money globally to keep up with the Federal Reserve's massive quantitative easing (QE) experiment has been necessary to offset the Fed's intended consequences to depress the U.S. dollar.

Everyone wants to export their way out of slow growth. The U.S. is no exception.

But printing money - in an articulated policy - to pump up asset prices that benefit from low interest rates, a depressed dollar that benefits exports, and positive overseas revenue translations has been fueling asset price inflation for five years. It's also been leading a beggar-thy-neighbor campaign. Neither of those are sustainable.

When stimulus slows - or if it stops being effective - we'll see whether there's sufficient global growth and fiat trust to avoid deflation.

That's what central banks worry about, a lot more than asset bubbles.

So, is deflation coming? Yes and no.

It's not coming in the way most people think about it... at least, not at first.

Here's What Keeps Me Up at Night

The deflation that's coming first is coming to financial assets.

That's what I worry about. I worry about asset bubble deflation.

I worry that we're now 10% above where stocks, as measured by the Dow Jones Industrials, were at their 2007 peak. That just means we've made back all those credit crisis and Great Recession losses - theoretically - and may have started a new bull market.

And a 10% up-leg doesn't impress me when it's built on leveraging a zero interest rate policy.

So we just had a better than expected jobs report where 204,000 people landed jobs instead of the 120,000 analysts expected? So what if the previous two months saw slight upward revisions?

The unemployment rate still went up, not down.

The labor participation rate fell by 0.04% (to 62.8%) in October. That's the lowest rate since March 1978. It means fewer people are looking for work. More people are disaffected.

Speaking of analysts' revisions, so what if 70% of half the companies in the S&P who've reported earnings for the third quarter beat analysts' expectations? They all lowered them after last quarter to make them easier to beat. And they're lowering them again now because CEOs are guiding future expectations down again.

These days, revenues are rising a lot more slowly than earnings - if they're rising at all.

This begs the question: If the rate of change of revenue growth slows and earnings growth from buybacks (which by some measures could have added 40% to rising prices), productivity gains, and cheap debt financing slows down, aren't stocks fully priced? What's left for them to feed on?

So what that consumer sentiment is rising with stock prices? It's been rising because of rising home prices, too. How many stocks and how many homes do most people own? Oh, that would be a lot fewer than before the housing bubble broke and stocks crashed.

So what if volatility is at historic lows and seemingly resting comfortably there? That goes hand in hand with margin debt being at record levels.

This Party Won't Last Forever

It's all just one big party - as long as there's punch in the bowl and revenue to feed profits.

And that's where we are. We're at the intersection where asset price inflation (driven by stimulus) meets the real economy's ability to produce goods and services to sell to people who can afford them, as opposed to being redistributed to them.

Tapering, when it comes, will be scary.

Not that it's coming soon. But it is coming.

That's good news. Because there's going to be plenty of time, maybe a few more quarters if we're lucky, to get sufficiently defensive and put on strategic short positions. Do that now, just in case global growth isn't there to augment the soon-to-be-diminishing returns of quackitative easing.

The market has upward momentum. We're going into the holiday season where spending picks up. There's a better than even chance if the market moves higher a lot of institutional managers will buy up the winners to window-dress their fourth-quarter and full-year returns.

It's unlikely that Helicopter Ben will slow down QE right before he leaves office next year. He'll let his successor make her own policy decisions. Why would Ben risk wrecking the rally that he engineered when he's on his way out the door?

Over in my patch, we're adding selectively to positions that pay nice dividends, and we'll be happy to add more to those positions if the market falters. We're playing in the hot technology patch, and we're starting to put on some defensive positions in the Capital Wave Forecast portfolio too.

You don't have to love this market, but you do have to be in it. And you have to understand that, love it or hate it, the market can't go up in a straight line forever.

The Most Unloved Bull in History Is Unloved for a Good Reason

Your high school science teacher always told you, "Correlation does not imply causation!"

But, as you can see, there is an extremely high (95%) correlation between the expansion of the Fed's balance sheet, and the S&P 500's gains over the past four years and more. This can't be a coincidence.

viernes, noviembre 15, 2013



Vaults are Booming! (in Asia)

David Franklin

Wednesday, November 13, 2013

For the better part of the last century, Switzerland has been a sanctuary for high-net-worth capital. Today, however, the rich are choosing a different destination to stash their wealthAsia. Gold, silver and collectibles are pouring into Singapore, Hong Kong and Shanghai, jurisdictions that now offer some of the most exclusive gold and silver vault options in the world.

With the recent wealth explosion in Asia, these clients are preferring to keep their collectibles and bullion close at hand. Recently published trade data supports our presumption that a significant amount of physical gold from ETF liquidations was indeed heading East. But where to exactly once it arrived? Several transactions have taken place this month which confirm the new Asian facilities as the final destination for the physical gold that has been transferred out of London and Swiss vaults.

This week, Malca-Amit Global Ltd., a global powerhouse in vaulting and secure transportation, opened a private vault in Shanghai with storage capacity for 2,000 metric tonnes of gold. However, besides being one of the largest vaults in Asia, it has even greater strategic value. It is located in the Shanghai Free-Trade Zone, a “testing ground for new policies” that opened in late September.

Identified as a reform hub for the 21st century, the sequestered area outside of Shanghai is an experimental zone for Chinese capitalism, in a similar category as Hong Kong. Joshua Rotbart, precious metals general manager at Malca-Amit stated that, “This place can be used as a trade hub basically, so foreign banks can trade with domestic banks within this facility, saving costs and time.” Given the large quantities of gold being traded with China, a facility like the Malca-Amit Global vault provides enormous benefits to the banks trading gold in Asia.1 The company has already opened vaults in several Asian trading locales and this latest facility increases its storage space significantly. Last September, the firm opened Hong Kong’s largest gold-storage facility, located on the ground floor of a building within the international airport compound, with the capacity for 1,000 metric tonnes of gold. Special facilities were also opened for up to 200 tonnes of silver in Singapore that are already 30 percent booked.2 These investments in Shanghai’s new free-trade zone, Singapore and Hong Kong reflect the shift in world bullion demand away from the U.S. and Europe toward Asia.

The big banks are getting involved too. A facility built a few years ago in Singapore provides ANZ, JPMorgan Chase & Co., UBS AG and Deutsche Bank AG with gold-storage services in Singapore, as the city hopes to take advantage of the bullion trade in the region. The new facility is sited at the Singapore FreePort, and can hold significant stores of metal.3

In a stunning transaction announced in October, a Chinese conglomerate purchased the headquarters of Chase Manhattan bank (JP Morgan Chase), and its underground facilities that include the world’s largest bank vault! Chase Manhattan Plaza was sold to Fosun International Ltd., the investment arm of China’s biggest closely held industrial group, for $725 million. Fosun, a conglomerate which invests in properties, pharmaceuticals and steel, is buying the 60-storey, 2.2 million square-foot, lower Manhattan tower, according to a statement it filed with Hong Kong’s stock exchange. The news that a Chinese company is to buy the largest commercial gold vault in the US is yet another reflection of China’s enthusiasm for stockpiling gold.4

Vault space was limited around the world, last year as most bullion-dealing banks doubled their vaulting fees. These new facilities in Asia further reflect the enormous increase in the physical precious metals trade and a requirement for secure storage.5 With these new vaults located in Asia (or now owned by Asians) it would appear the massive amounts of gold being shipped East will not see the inside of a London or Swiss vault ever again.

1 Massive private gold vault opens in Shanghai Free-Trade Zone.
2 Singapore silver vault set to meet strong Asian demand.
3 ANZ Opens 50-Ton Gold Vault in Singapore as Demand Expands.
4 JPMorgan Sells Chase Manhattan Plaza in NYC to China’s Fosun.
5 Deutsche to open gold vault in London.

The Real Heroes of the Global Economy

Dani Rodrik

NOV 13, 2013
 Newsart for The Real Heroes of the Global Economy


PRINCETON Economic policymakers seeking successful models to emulate apparently have an abundance of choices nowadays. Led by China, scores of emerging and developing countries have registered record-high growth rates over recent decades, setting precedents for others to follow.

While advanced economies have performed far worse on average, there are notable exceptions, such as Germany and Sweden.Do as we do,” these countries’ leaders often say, “and you will prosper, too.”
Look more closely, however, and you will discover that these countries’ vaunted growth models cannot possibly be replicated everywhere, because they rely on large external surpluses to stimulate the tradable sector and the rest of the economy. Sweden’s current-account surplus has averaged above a whopping 7% of GDP over the last decade; Germany’s has averaged close to 6% during the same period.
China’s large external surplusabove 10% of GDP in 2007 – has narrowed significantly in recent years, with the trade imbalance falling to about 2.5% of GDP. As the surplus came down, so did the economy’s growth rateindeed, almost point for point. To be sure, China’s annual growth remains comparatively high, at above 7%. But growth at this level reflects an unprecedented – and unsustainablerise in domestic investment to nearly 50% of GDP. When investment returns to normal levels, economic growth will slow further.
Obviously, not all countries can run trade surpluses at the same time. In fact, the successful economies’ superlative growth performance has been enabled by other countries’ choice not to emulate them.
But one would never know that from listening, for example, to Germany’s finance minister, Wolfgang Schäuble, extolling his country’s virtues. “In the late 1990’s, [Germany] was the undisputedsick man of Europe,” Schäuble wrote recently. What turned the country around, he claims, was labor-market liberalization and restrained public spending.
In fact, while Germany did undertake some reforms, so did others, and its labor market does not look substantially more flexible than what one finds in other European economies. A big difference, however, was the turnaround in Germany’s external balance, with annual deficits in the 1990’s swinging to a substantial surplus in recent years, thanks to its trade partners in the eurozone and, more recently, the rest of the world. As the Financial Times’ Martin Wolf, among others, has pointed out, the German economy has been free-riding on global demand.
Other countries have grown rapidly in recent decades without relying on external surpluses. But most have suffered from the opposite syndrome: excessive reliance on capital inflows, which, by spurring domestic credit and consumption, generate temporary growth. But recipient economies are vulnerable to financial-market sentiment and sudden capital flight – as happened recently when investors anticipated monetary-policy tightening in the United States.
Consider India, until recently another much-celebrated success story. India’s growth during the past decade had much to do with loose macroeconomic policies and a deteriorating current account – which recorded a deficit of more than 5% of GDP in 2012, having been in surplus in the early 2000’s. Turkey, another country whose star has faded, also relied on large annual current-account deficits, reaching 10% of GDP in 2011.
Elsewhere, small, formerly socialist economiesArmenia, Belarus, Moldova, Georgia, Lithuania, and Kosovohave grown very rapidly since the early 2000’s. But look at their average current-account deficits from 2000 to 2013 – which range from a low of 5.5% of GDP in Lithuania to a high of 13.4% in Kosovo – and it becomes evident that these are not countries to emulate.
The story is similar in Africa. The continent’s fastest-growing economies are those that have been willing and able to allow yawning external gaps from 2000 to 2013: 26% of GDP, on average, in Liberia, 17% in Mozambique, 14% in Chad, 11% in Sierra Leone, and 7% in Ghana. Rwanda’s current account has deteriorated steadily, with the deficit now exceeding 10% of GDP.
The world’s current-account balances must ultimately sum up to zero. In an optimal world, the surpluses of countries pursuing export-led growth would be willingly matched by the deficits of those pursuing debt-led growth. In the real world, there is no mechanism to ensure such an equilibrium on a continuous basis; national economic policies can be (and often are) mutually incompatible.
When some countries want to run smaller deficits without a corresponding desire by others to reduce surpluses, the result is the exportation of unemployment and a bias toward deflation (as is the case now). When some want to reduce their surpluses without a corresponding desire by others to reduce deficits, the result is a “sudden stop” in capital flows and financial crisis. As external imbalances grow larger, each phase of this cycle becomes more painful.
The real heroes of the world economy – the role models that others should emulate – are countries that have done relatively well while running only small external imbalances. Countries like Austria, Canada, the Philippines, Lesotho, and Uruguay cannot match the world’s growth champions, because they do not over-borrow or sustain a mercantilist economic model.

Theirs are unremarkable economies that do not garner many headlines. But without them, the global economy would be even less manageable than it already is.

Dani Rodrik is Professor of Social Science at the Institute for Advanced Study, Princeton, New Jersey. He is the author of One Economics, Many Recipes: Globalization, Institutions, and Economic Growth and, most recently, The Globalization Paradox: Democracy and the Future of the World Economy.