martes, febrero 04, 2014



China’s Risky Credit Boom

Andrew Sheng, Xiao Geng

JAN 31, 2014

HONG KONG Credit in China is growing at a breakneck pace, having increased from 125% of GDP in 2008 to 215% in 2012. Local-government debt has soared by 70% since 2009, reaching almost $3 trillion last June. This is raising serious concerns about the level of risk in China’s financial system.

China’s rapid credit growth reflects the government’s move to loosen restrictions on investment, as well as very low interest rates in the formal banking sector. Since 2000, the one-year fixed-term deposit rate in China has remained in the 2-4% range, roughly equal to the consumer inflation rate. The lending rate in the formal banking system – which provides credit mostly to state-owned enterprises (SOEs), urban mortgage borrowers, and government projects – has also remained relatively stable, at 5.5-7%.

Unsurprisingly, the combination of easy credit, low official rates, and high demand caused property prices to surge by 300-500% in some Chinese cities over the last decade. This has led to broad-based wealth distribution, with 80% of urban households owning their homes. But access to cheap credit remains a privilege reserved for a select group, which has amassed property and real estate, while new entrants to the labor market and small and medium-size enterprises have struggled to acquire credit at reasonable rates.

Chinese authorities, recognizing that excessive credit was creating domestic economic imbalances, have been engaged in monetary tightening since 2010, slowing the pace of money-supply growth from more than 25% in 2009 to less than 14% last year. As new credit increased by only 9.7% in 2013, tight interbank liquidity conditions arose in June and December, with average interbank rates spiking to around 12% and 9%, respectively.

Since the beginning of this year, regulators have also begun to rein in shadow banking, which gained ground in the wake of the global economic crisis. With China’s export sector facing labor-cost increases and the renminbi appreciating against the US dollar by 3% annually since 2005, conditions deteriorated sharply when crisis struck the advanced economies. Indeed, after 2008, demand for Chinese exports fell, and buyers began to demand seller financing, cutting Chinese firms’ profit margins, cash flow, and liquidity.

The shadow-banking system emerged to meet the demand from private firms and SOEs for extra liquidity to help them cope with the slowing economy and fulfill their investment commitments. Private-sector entrepreneurs in cities like Wenzhou were willing to pay annual interest rates as high as 15-20%.

On the supply side, savers – including wealthy households and corporations with surplus cash – wanted positive real interest rates on their deposits. Loan-guarantee institutions, trust companies, and others sought to benefit from the gap between the 3.5% return on one-year fixed deposits in the official banking system and rates of up to 20% in the shadow-banking sector. The result was a 43% increase in shadow-banking credit last year, accounting for 29% of China’s total credit.

Chinese policymakers now must determine how to unify the official and shadow rates without excessively disrupting the system – an objective that is made all the more challenging by the government’s recent decision to give market forces a greater role in resource allocation. If the unified rates are too high, the economy could come to a halt; capital inflows could negate the policy’s impact; or the asset bubble could pop, putting serious pressure on banks’ balance sheets.

What the debate really comes down to is liquidity versus solvency. Excessively loose liquidity and negative real interest rates obscure the credit risks in the system, while excessively high real rates could transform illiquidity into insolvency. The question is whether borrowers can sustain much higher interest rates and still service their debts.

Proper credit discipline would ensure that private firms paying excessively high interest rates ultimately exit the game. But, while local-government financing platforms nominally carry state-credit status, some might not have the cash flow to make their payments, either. Should they have to pay unsustainably high interest rates?

In other words, the problem stems from the quality of assets (or investments) that underlie China’s credit growth. A study of better-performing cities like Foshan suggests that some municipal-level enterprises will survive, owing to high productivity and sound fiscal management. But, even at a 7% interest rate, some towns will not be able to repay their debts – a situation that will demand either that platform companies declare bankruptcy or that municipal debt is restructured.

The current divergence between official and shadow lending rates parallels the gap between the renminbi’s official and swap market (unofficial) exchange rates in the 1980’s. The unification of the exchange rates in 1994 improved the market mechanism substantially, thereby enabling China’s foreign trade to grow exponentially.

At the domestic level, the current policy dilemma is how to reconcile the economy’s liquidity needs with the solvency of the system as a whole (rather than that of individual borrowers). If interest rates remain too low, the shadow-banking system will squeeze out the formal sector. If money supply is too tight, the real economy will suffer, in turn damaging the financial sector.

The good news is that higher interest rates in advanced economies create more policy space for China to adjust domestic rates. A combination of price and quantitative adjustments would buy time for the real sector to improve productivity and for policymakers to reduce SOEs’ excess capacity.

In short, given China’s large state-owned sector, the transition to market-based interest rates will require strong government action to control public debt (especially local-government debt), while ensuring that there is enough credit to accommodate the growth in the volume of transactions and the increase in asset prices. These complex reforms – which require that both formal and shadow-banking institutions adjust to a new, risk-based environment certainly will entail some pain; but they are critical to putting China on a stable and sustainable growth path.

Andrew Sheng, President of the Fung Global Institute, is a former chairman of the Hong Kong Securities and Futures Commission, and is currently an adjunct professor at Tsinghua University in Beijing. His latest book is From Asian to Global Financial Crisis.

Xiao Geng is Director of Research at the Fung Global Institute.

Why emerging markets are unlikely to sway the Fed

February 2, 2014 9:00 pm

by Robin Harding

After the Reserve Bank of India’s Raghuram Rajan took the Fed and other developed country central banks to task this week for ignoring turmoil in emerging markets, Richard Fisher, president of the Dallas Fed, gave the standard retort on Friday. He said the US central bank must make policy according to what is best for America.

Doing so means the only reason the Fed would change its monetary policy is if trouble in emerging markets had a direct effect on the US. There are two main channelsexports and financial markets – but neither looks likely to hurt the US unless the EM turmoil gets a lot more severe. Thus while the Fed may make a greater show of consultation, and soak up some flak at the G20, its actions this year are unlikely to change.


If interest rate rises drove big emerging markets into recession, then that would hit US exports, but any plausible effect is very small. A proper estimate needs a big equilibrium model, because you have to consider currency and feedback effects, but you can get a pretty good idea just by looking at where most US exports go.

RankCountryExportsPercent of Total Exports
Total, All Countries1,448.2100.0%
Total, Top 15 Countries1,033.671.4%
5United Kingdom44.03.0%
9Hong Kong38.82.7%
10Korea, South37.62.6%

The only member of the ‘Fragile Five’ to make the Top 15 is Brazil. Brazil buys 2.8 per cent of US exports. Meanwhile, exports equal only 13 per cent of US output. Thus exports to Brazil amount to less than 0.4 per cent of the US economy.

It quickly becomes clear that only a very broad emerging market slowdownone that included China or Mexico, for example – would have much effect on US exports. It remains the case that a US recession can plunge the rest of the world into an export crisis; there are not many countries that can have the same effect on the US.

Financial Markets

A more plausible way for an emerging market shock to hit the US is via financial markets. Corporate America earns a good share of its profits from emerging markets. The Asian financial crisis in 1997 and the collapse of Long-Term Capital Management in 1998 show how financial shocks from emerging markets can quickly hit Wall Street.

But as Capital Economics point out, both the Asian crisis and LTCM had short-lived effects on US stocks, and the S&P 500 ended up rising by around 25 per cent in both of 1997 and 1998.

The effects have been similarly modest so far in 2013 and 2014. The S&P 500 is less than 4 per cent below its all time high. A deeper EM crisis could mean greater losses for US banks and investors but so far there is hardly an effect on financial conditions that would justify a change of Fed policy.

Flight to Safety?

So far the troubles in emerging markets, far from being a drag on the US economy, have if anything been a net stimulus. That is because ten-year bond yields have fallen. It is hard to know whether that reflects capital flight to US Treasuries or merely a little less optimism about the US growth outlook. Either way, it loosens financial conditions in the US.

An emerging market crisis could end up influencing the Fed sometime this year. But it would have to become much more of a crisisrather than just the wobbles we have seen so far – to activate these channels and thus endanger the US economy.

Gold Fix Study Shows Signs of Decade of Bank Manipulation

By Liam Vaughan

Feb 28, 2014

The London gold fix, the benchmark used by miners, jewelers and central banks to value the metal, may have been manipulated for a decade by the banks setting it, researchers say.

Unusual trading patterns around 3 p.m. in London, when the so-called afternoon fix is set on a private conference call between five of the biggest gold dealers, are a sign of collusive behavior and should be investigated, New York University’s Stern School of Business Professor Rosa Abrantes-Metz and Albert Metz, a managing director at Moody’s Investors Service, wrote in a draft research paper.

“The structure of the benchmark is certainly conducive to collusion and manipulation, and the empirical data are consistent with price artificiality,” they say in the report, which hasn’t yet been submitted for publication.It is likely that co-operation between participants may be occurring.”

The Libor Scandal Sets Off a Wave of Probes

The paper is the first to raise the possibility that the five banks overseeing the century-old rate -- Barclays Plc (BARC), Deutsche Bank AG (DBK), Bank of Nova Scotia, HSBC Holdings Plc (HSBA) and Societe Generale SA (GLE) -- may have been actively working together to manipulate the benchmark. It also adds to pressure on the firms to overhaul the way the rate is calculated. Authorities around the world, already investigating the manipulation of benchmarks from interest rates to foreign exchange, are examining the $20 trillion gold market for signs of wrongdoing.

Union Jacks

Officials at London Gold Market Fixing Ltd., the company owned by the banks that administer the rate, referred requests for comment to Societe Generale, which holds the rotating chairmanship of the group. Officials at Barclays, Deutsche Bank, HSBC and Societe Generale declined to comment on the report and the future of the benchmark. Joe Konecny, a spokesman for Bank of Nova Scotia, didn’t respond to requests for comment.

Abrantes-Metz advises the European Union and the International Organization of Securities Commissions on financial benchmarks. Her 2008 paperLibor Manipulation?helped uncover the rigging of the London interbank offered rate, which has led financial firms including Barclays Plc and UBS AG to be fined about $6 billion in total. She is a paid expert witness to lawyers, providing economic analysis for litigation. Metz heads credit policy research at ratings company Moody’s.

The rate-setting ritual dates back to 1919. Dealers in the early years met in a wood-paneled room in Rothschild’s office in the City of London and raised little Union Jacks to indicate interest. Now the fix is calculated twice a day on telephone conferences at 10:30 a.m. and 3 p.m. London time. The calls usually last 10 minutes, though they can run more than an hour.

Unregulated Process

Firms declare how many bars of gold they want to buy or sell at the current spot price, based on orders from clients and themselves. The price is increased or reduced until the buy and sell amounts are within 50 bars, or about 620 kilograms, of each other, at which point the fix is set.

Traders relay shifts in supply and demand to clients during the call and take fresh orders to buy or sell as the price changes, according to the website of London Gold Market Fixing, where the results are published. At 3 p.m. yesterday, the price was $1,332.25 an ounce. The process is unregulated and the five banks can trade gold and its derivatives throughout the call.

Bloomberg News reported in November concerns among traders and economists that the fixing banks and their clients had an unfair advantage because information gleaned from the calls provided an insight into the future direction of prices and banks can bet on spot and derivatives markets during the call.

All Down

Abrantes-Metz and Metz screened intraday trading in the spot gold market from 2001 to 2013 for sudden, unexplained moves that may indicate illegal behavior. From 2004, they observed frequent spikes in spot gold prices during the afternoon call. The moves weren’t replicated during the morning call and hadn’t happened before 2004, they found.

Large price moves during the afternoon call were also overwhelmingly in the same direction: down. On days when the authors identified large price moves during the fix, they were downwards at least two-thirds of the time in six different years between 2004 and 2013. In 2010, large moves during the fix were negative 92 percent of the time, the authors found.

There’s no obvious explanation as to why the patterns began in 2004, why they were more prevalent in the afternoon fixing, and why price moves tended to be downwards, Abrantes-Metz said in a telephone interview this week.

“This is a first attempt to uncover potentially manipulative behavior and the results are concerning,” she said. “It’s down to regulators to establish why there are such striking patterns but banks have the means, motive and opportunity to manipulate the fixing. The results are consistent with the possibility of collusion.”

Bafin, FCA

Deutsche Bank, Germany’s largest lender, said in January that it will withdraw from the panels setting the gold and silver fixings. German financial markets regulator Bafin interviewed the Frankfurt-based bank’s employees as part of a probe into the potential manipulation of gold and silver prices.

“In general, research that finds certain price patterns does not as such constitute evidence of manipulation,” said Thorsten Polleit, chief economist at Frankfurt-based precious-metals broker Degussa Goldhandel GmbH and a former Barclays economist. However, it might encourage interest in finding out more about the sources of these price patterns.”

‘Appropriate Oversight’

The five banks that oversee the fixing set up a steering committee and will appoint external advisers to consider reforms before EU legislation on financial benchmarks’ regulation and oversight comes into force, Bloomberg reported last month.

Britain’s Financial Conduct Authority is also scrutinizing how prices are calculated. The regulator published a report this week outlining its remit for regulating commodities including gold, saying that while it’s responsible for commodities derivatives, it doesn’t regulate physical commodities.

Abusive behavior can occur in the physical commodity markets which in turn can have an impact on, or be directly linked with, financial market activity and prices,” the FCA said in the report. “The regulatory regime -- both in the U.K. and internationally -- needs to be adapted to ensure robust and appropriate oversight.”