Friday, January 9, 2009

The Great Uncoupling

There have been a number of intriguing developments in the last week that have potentially big implications for U.S.-China commercial, financial & trade relations.

Keen observers of China's banking scene may remember that a number of big western financial institutions, including Bank of America, Citigroup, UBS, Goldman Sachs, American Express and Royal Bank of Scotland have invested in various big Chinese banks a few years ago, primarily before those Chinese banks went public in western and/or the Hong Kong stock exchanges. At the time, these investments made plenty of sense for both sides. The western investors, of course, got to jump into -- even if a bit passively -- the Chinese banking markets. Those markets had been largely closed to their significant participation before China's accession to the WTO. After China became a member of the WTO, altho the banking market technically was partially opened, only a few foreign banks hopped over the border. Not that the Chinese government exactly made it particularly easy, but that's a story for another day. The one avenue where the gates swung wide open, altho the gatekeepers were still on duty, was equity investments in Chinese banks. With the prospects of the big four (Industrial & Commercial Bank of China, China Construction Bank, Bank of China, and Agricultural Bank of China) going public in the near future, the chance to jump in before the expected stampede for public shares was irresistible. For the Chinese side, there were big advantages. Looking forward to impending IPO's, the Chinese banks got a bit of legitimacy. If Bank of America buys shares in a bank, it must be a good investment. Or so the reasoning went at the time.
In addition, the then badly managed Chinese banks, in their rush towards legitimacy, could rightly claim that they had not only dumped a lot of their bad loans but they also were getting operational advice & counsel from their western brethren. In hindsight, we can all hope that they didn't learn too much.

Since those days in the not too distant past, the banking world has turned topsy-turvy. Those western pillars of the banking world turned out to have been infinitely more poorly managed than the big four Chinese banks. After the events of the last few months and the effective partial nationalization of many, if not all of those western banks, the scene has become truly surreal. Follow the logic. The big U.S. banks, with their significant ownership in major Chinese banks, are now largely owned by the U.S. Treasury. That means that the U.S. Government owns a chunk of the Big Four Chinese banks. Since the Big 4 are partially owned by the Chinese Governmentas well as the investing public, it means that the Chinese & U.S. Governments are, effectively, co-investors in the banking business. Mao Zedong & Ronald Reagan must both be squirming around in their graves, wondering what on earth could have happened.

But that's not the story. Now, in an effort to raise badly needed funds, Bank of America has sold off some of its Chinese bank stock for approx. $2.8 billion (for a profit of a bit more than $1.1 billion -- we're glad something has worked out for them, by the way). Analysts expect that B of A will be selling more stock (and they've got plenty left). In addition, other western banks are expected to begin to sell some of their Chinese bank holdings as well over the next few months as restrictions on stock sales expire.

So that's the first part of the story: Western banks begin divesting Chinese bank stocks.

The second and also intriguing development is this story, reported in the New York Times, among others:

China has bought more than $1 trillion of American debt, but as the global downturn has intensified, Beijing is starting to keep more of its money at home, a move that could have painful effects for American borrowers.

The declining Chinese appetite for United States debt, apparent in a series of hints from Chinese policy makers over the last two weeks, with official statistics due for release in the next few days, comes at an inconvenient time . . .

In the last five years, China has spent as much as one-seventh of its entire economic output buying foreign debt, mostly American. In September, it surpassed Japan as the largest overseas holder of Treasuries.

But now Beijing is seeking to pay for its own $600 billion stimulus — just as tax revenue is falling sharply as the Chinese economy slows. Regulators have ordered banks to lend more money to small and medium-size enterprises, many of which are struggling with lower exports, and to local governments to build new roads and other projects.


While this is not, in itself, striking news (it follows reports last year of China's national sovereign fund,
The China Investment Corporation, coming under popular criticism in China after some of its less-than-stellar western investments began showing the strains of the times), it comes, as The Times notes, at a rather inconvenient time for the U.S. As mentioned previously in this blog and numerous other places, there's a lot of U.S. Treasury debt that must be rolled over soon and a big bill to be paid, financed by soon to be issued, crisp new Treasuries, for the first & second phases of the Big American Rescue Plan. That will mean that, in order to attract investors to the Treasury auctions, interest rates will need to be higher than they are now. Interest rates going up means Treasury prices go down. And the current Chinese holdings aren't immune to those market forces. It doesn't mean, of course, that Chinese bond buyers will entirely sit out upcoming U.S. Government bond auctions, but they can expect to demand higher returns. And we wouldn't be surprised if they bought less than they have in the past. And you can't blame them; you'd do the same thing.

Let the Great Uncoupling Begin!

Tuesday, January 6, 2009

Savings Imbalances & the Washington Follies

As I've mention before, these are interesting times we are living through & there is no end to the fascinating tidbits one can find in the press. One of the more valuable series, presumably ongoing, is the New York Times series titled The Reckoning about the economic tumble of the last year or so. And one of my favorites (and more revealing) in the series was a piece that ran the day after Christmas titled Dollar Shift: Chinese Pockets Filled as Americans' Emptied. While I agree with the basic premise -- that Americans, both our government and our households, have been living "high on the hog" through over reliance on debt -- is correct, there are some interesting insights that are left unmentioned. First of all, economists have recognized this problem for years and some, like Morgan Stanley's Stephen Roach, have been been persistent in eloquently & tirelessly telling everyone within earshot that this phenomena would come to a disaster sooner or later. What the Times' article points out is that our erstwhile Secretaries of Treasury in recent years, altho aware of the imbalance, didn't do much effective about it. The prevailing view seems to have been to blame the Chinese and to press the Chinese government to somehow get the Chinese people to increase their spending & decrease their savings. The average Chinese consumer can certainly afford to save less -- the aggregate savings rate in China is generally higher than 30% and sometimes up to 50% of income -- but the Chinese government has little it can do to prod the masses to buy more. For one thing, the vast majority of Chinese people remain poor. Consumption in the cities by the emerging Chinese middle class is a combination of healthy (lots of new cars & a vastly larger private housing market than only a few years ago) and frugal. A visit to those glossy new shopping malls leaves one with the impression that Chinese love to window shop but hate to part with their cash. Or, when they do, its at the shopping areas where you can buy things at sharply lower prices than at the big name shops. Think Prada & Gucci vs. the little clothing stalls on the west side of Beijing; the former are uncrowded and unrushed, while prowling the latter is a contact sport like a rugby scrum. Other big Chinese cities are no different.

One of the proposals out of Washington's policymakers has been for the Chinese government to improve health care funding along with retirement pensions because that's, they think, why the Chinese peple save so much; to save for a rainy day. The irony of suggestions like that from the U.S., where health care funding is famously inadequate and where the U.S.'s Social Security retirement system just barely missed being largely handed over to the thieves of Wall Street, is hard to miss. In any case, it wouldn't have worked. Chinese do not save so much solely out fear that they will end up poor and sick or poor and retired. The entire world-view of traditionally minded Chinese is, apparently, beyond the comprehension of Treasury Dept. policy wonks. Chinese do not generally get into debt to others because they know what so many Americans are only now discovering: getting in debt to the levels common in America means giving up control of your life to someone else; it is inherently risky.

In China, where success is a recent commodity much less taken for granted and failure & poverty are often multi-generational companions, people are much more conservative and tend to see themselves as part of a family continuum of ancestors, extended family and yet-to-be-born descendants. Having family money safely put away is honorable, while getting in debt is both shameful in itself and risks multi-generational ruination. In some parts of America, sefishness and immediate gratification are all-too-common (along with a tendency to blame others for one's failures). The average Chinese, in contrast, is nothing if not self reliant. These are, of course, generalizations. There are many self-reliant Americans who are not mired in a debtor culture just as there are plenty of Chinese who live way beyond their means and are addicted to conspicuous consumption. Nevertheless, the generalizations are useful and are clearly reflected in the aggregate economic data of consumer behavior.

The second insight is the often repeated description of the U.S.'s current Treasury Secretary as someone who is an expert on China. While he appears to have been in China many times in his tenure with Goldman Sachs, he has not been able to accomplish very much in China as Treasury Secretary. While I don't know him at all, I can only speculate that his self-described 70+ trips to China had been directed at senior Chinese from both the government & private sector. His down-time in Beijing, Shanghai and elsewhere was probably with his own employees and with the Chinese government officials, Chinese bankers, and Chinese entrepreneurs that American investment bankers and business leaders visiting China usually seek out. While there's nothing wrong with that at all, it doesn't make you an expert on China. It gives you only a highly choreographed glimpse of a tiny slice of a vast and vastly complex place. Add to that the tendency of Chinese to frequently tell foreigners only what they think those foreigners expect to hear. Stir both up in a pot with the typical Wall Street bankers' "Masters of the Universe" arrogance and you end up with the kind of delusional policy presumptions that have boxed the U.S. in. The one consolation is that the Chinese have as little room to maneuver as the U.S. does.