How Will China’s Slow Down Impact the World?

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Global finance leaders believe China will weather its slowing growth and manage a successful transition from an export to a consumer economy despite a huge buildup of internal debt in the world’s second largest economy.

The International Monetary Fund believes the Chinese economy will grow 6.8 per cent this year and 6.3 per cent in 2016, slower than recent levels but still enough to keep driving global economic growth when other positives have largely disappeared.

French Finance Minister Michel Sapin is among the optimists, along with Britain’s George Osborne and IMF chief Christine Lagarde.

China’s Deputy Central Bank Governor, Yi Gang, was keen to reassure his peers at this week’s IMF meetings in Lima, saying a recent devaluation was a one-off and that China’s economy was stable.

Yet cracks are already appearing in China, an economy whose red-hot growth of almost 10 per cent a year for 30 years fueled a commodity super-cycle that in 2008 pushed oil prices as high as $145 a barrel, and inflated demand for iron ore and edible oils, as well as industrial goods from advanced economies like Germany.

It is not just China that is a risk – although it is by far the biggest one to the relatively rosy IMF forecasts of global economic growth of 3.1 per cent this year and 3.6 per cent in 2016.

In Germany exports to China, Brazil and Russia account for 3.4 per cent of gross domestic product, according to investment bank Barclays, a risk for Europe’s largest economy. China alone accounts for 10 per cent of Germany’s auto exports.

A sharp drop in German exports  in August, which fell at their fastest pace since the 2009 financial crisis, is likely to be related to the fall in trade in Asia, Barclays said. Industrial production and factory orders also declined.

“Because of China’s weight in global production and trade, and because of the high commodity intensity of its production and demand, China’s recession is the one that matters most for the global economy,” Citi’s chief economist Willem Buiter has warned.

The IMF Global Financial Stability report said that over-borrowing by Chinese companies was equivalent to a quarter of gross domestic product.

While China’s August stock market crash and sudden devaluation rattled global markets, it may have just been a foretaste of things to come if China does not address its huge debt problems.

“Direct financial spillovers include a possibly adverse impact on the asset quality of at least $800 billion of cross-border bank exposures,” the IMF report said.

It calculates that if a tightly wound credit cycle in emerging economies, including China, unwinds with rising corporate default rates, aggregate global output could be as much as 2.4 per cent lower by 2017 relative to the IMF’s baseline forecast.

“China still has policy buffers to absorb financial shocks, including a relatively strong public sector balance sheet, but over-reliance on these buffers could exacerbate existing vulnerabilities,” the IMF said.

Addressing Corruption in Greece

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Cash-strapped Greece loses up to 20 billion euros a year to tax evasion and smuggling, and more than a million people and businesses are under investigation, a finance official said on Friday.

“Tax evasion and smuggling are worth between 15-20 billion euros ($17-23 billion) a year,” junior finance minister Tryfon Alexiadis told reporters.

The Greek economic crimes agency (Sdoe) is currently investigating 38,000 cases involving 1.3 million people and businesses, he said.

And five years after receiving insider data on the Swiss bank holdings of over 2,000 Greeks — the so-called Lagarde list — only 136 cases have been conclusively checked, he added.

The left-wing government of Prime Minister Alexis Tsipras has accused its conservative and socialist predecessors of protecting business friends from tax checks.

The list had been sent in 2010 to then socialist finance minister George Papaconstantinou by Christine Lagarde, International Monetary Fund chief and at the time French finance minister. Lagarde had got it from an HSBC whistleblower.

A few years later, it emerged that three members of Papaconstantinou’s family had been on the list, but their names were excised and they escaped scrutiny.

Papaconstantinou denied any wrongdoing but a court in March found him guilty of tampering with the data.

Alexiadis on Friday said that the statute of limitations on the Lagarde list investigation was due to expire on December 31, but the government would take steps to extend the prosecution period by another year.

He added that the government was also poring through bank transfers and data on Greeks with property in London and yachts registered in the Netherlands in search of undeclared income.

“We are not going to cover up anything,” Alexiadis said.

Emerging Economies’ Debt

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IMF meetings in Lima, Peru suggest that debt in emerging countries if difficult to measure and even find.  Yet this debt is an important factor in evaluating these economies.

Carmen Reinhart writes:  When central bankers and finance ministers from around the globe gathered for the International Monetary Fund’s annual meetings here in Lima, Peru, which ended on Sunday, the emerging world was rife with symptoms of increasing economic vulnerability. Gone are the days when IMF meetings were monopolised by the problems of the advanced economies struggling to recover from the 2008 financial crisis. Now, the discussion has shifted back toward emerging economies, which face the risk of financial crises of their own.

While no two financial crises are identical, all tend to share some telltale symptoms: a significant slowdown in economic growth and exports, the unwinding of asset-price booms, growing current-account and fiscal deficits, rising leverage, and a reduction or outright reversal in capital inflows. To varying degrees, emerging economies are now exhibiting all of them.

The turning point came in 2013, when the expectation of rising interest rates in the United States and falling global commodity prices brought an end to a multi-year, capital-inflow bonanza that had been supporting emerging economies’ growth. China’s recent slowdown, by fuelling turbulence in global capital markets and weakening commodity prices further, has exacerbated the downturn throughout the emerging world.

These challenges, while difficult to address, are at least discernible. But emerging economies may also be experiencing another common symptom of an impending crisis, one that is much tougher to detect and measure: hidden debts.

Sometimes connected with graft, hidden debts do not usually appear on balance sheets or in standard databases. Their features morph from one crisis to the next, as do the players involved in their creation. As a result, they often go undetected, until it is too late.

Indeed, it was not until after the eruption of the 1994-1995 peso crisis that the world learned that Mexico’s private banks had taken on a significant amount of currency risk through off-balance-sheet borrowing (derivatives). Likewise, before the 1997 Asian financial crisis, the IMF and financial markets were unaware that Thailand’s central-bank reserves had been nearly depleted (the $33 billion total that was reported did not account for commitments in forward contracts, which left net reserves of only about $1 billion). And, until Greece’s crisis in 2010, the country’s fiscal deficits and debt burden were thought to be much smaller than they were, thanks to the use of financial derivatives and creative accounting by the Greek government.

So the great question today is where emerging-economy debts are hiding. And, unfortunately, there are severe obstacles to exposing them – beginning with the opaqueness of China’s financial transactions with other emerging economies over the past decade.

During its domestic infrastructure boom, China financed major projects – often connected to mining, energy, and infrastructure – in other emerging economies. Given that the lending was denominated primarily in US dollars, it is subject to currency risk, adding another dimension of vulnerability to emerging-economy balance sheets.

But the extent of that lending is largely unknown, because much of it came from development banks in China that are not included in the data collected by the Bank for International Settlements (the primary global source for such information). And, because the loans were rarely issued as securities in international capital markets, it is not included in, say, World Bank databases, either.

Even where data exists, the figures must be interpreted with care.

Other forms of borrowing – such as trade finance, which is skewed toward shorter maturities – are not included in these figures. Currency-swap agreements, which have been important for Brazil and Argentina, must also be added to the list. (This highlights the importance of tracking net, rather than gross, reserves.)

In short, though emerging economies’ debts seem largely moderate by historic standards, it seems likely that they are being underestimated, perhaps by a large margin. If so, the magnitude of the ongoing reversal in capital flows that emerging economies are experiencing may be larger than is generally believed – potentially large enough to trigger a crisis. In this context, keeping track of opaque and evolving financial linkages is more important than ever.

Debt in emerging countries

Harvard Deals with Frothy Markets?

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Managers of Harvard’s endowment are looking for help in preparing for the market’s downside.

Lucinda Shen writes: America’s largest university endowment wants more money managers who will bet on a stock falling.

The chief executive of Harvard Management Company, which manages the university’s $37.6 billion endowment, on Tuesday warned about “potentially frothy markets.”

Stephen Blythe added that the endowment is now looking for stock managers that will short stocks as well as go long.

“We have renewed focus on identifying public equity managers with demonstrable investment expertise on both the long and short sides of the market,” he said.

In an annual letter to investors, Blyth wrote that the market “presents various challenges to investors” and that it is time to proceed “with caution in several areas of the portfolio.”

The endowment returned 5.8% through June 30, though the performance of the absolute return portfolio was underwhelming. The $6 billionportfolio returned 0.1% in fiscal year 2015. That compares to a benchmark of 3.5%, according to the report.

Blyth said the endowment was seeking to decrease exposure to equities and inflation and increase exposure to the dollar, bonds, and the high yield market.

How to Deal with Frothy Markets?

Shell Companies in the Seychelles

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An Indian-born oligarch who purchased M.C. Hammer’s former mansion in California may have followed the previous owner into decadence and bankruptcy, but, unlike the bejeweled and balloon-panted rapper, this flamboyant figure appears to have benefited from the relaxed laws of an island nation to keep his assets out of the hands of his creditors.

Once the owner of an estimated $3 billion business empire, largely founded on India’s telecom industry, Chinnakannan Sivasankaran, or Siva as his friends call him, filed for bankruptcy in August 2014 in Seychelles, following his loss, in British High Court, of a civil case brought against him by an erstwhile partner, a subsidiary of the Bahrain Telecommunications Company, or Batelco.

It was decided that Siva and his Bermuda-registered company Siva Limited should pay the Gulf-based company $212 million by June 26, 2014.

However, even before the trial began, the oligarch used his Seychellois citizenship to arrange a swift legal split from his wife, to whom he then transferred at least $95 million in assets—39 plots of land, one island and numerous corporate holdings registered in Seychelles and the British Virgin Islands, including those that owned even more real estate—as part of the divorce settlement.  Not that bankruptcy would have necessarily hurt Batelco’s chances of recovering their money under Seychelles’ prior law on insolvency. But about a year after Siva lost his case in Britain, the island nation “reformed” its bankruptcy statute.

The story highlights the role of questionable offshore tax shelters, of which Seychelles is a small but hyper-caffeinated example, in allowing an international elite to transcend borders and sovereign jurisdictions in order to safeguard their assets.

The 59-year-old Siva first rose to prominence in India’s southern state of Tamil Nadu in the mid-1980s after he acquired Sterling Computers and sold cut-rate PCs in a burgeoning subcontinental tech industry, transforming the company into one of India’s top three in its field. Frequently adorned with gold Rolexes and known for his obsession with health food and personal fitness, Siva formerly lived and worked out of presidential suites at the Ritz Carlton and Pan Pacific hotels in Singapore.

Over the past four decades, he’s had a hand in all sorts of things: engineering, shipping, commodities trading, and alternative energy. According to NGO Grain, an international nonprofit that supports small farmers, his Siva Group gobbled up about “a million hectares of land in the Americas, Africa and Asia, primarily for oil palm plantations,” making him “one of the world’s largest farmland holders.”

Siva aimed to set up a new U.S. operation by relocating to Fremont, California, in 1996, buying M.C. Hammer’s mansion following the latter’s own loss of fortune, but by the mid-2000s, he opted to move to Seychelles and became a full citizen. This decision was followed almost immediately by his nomination as ambassador-at-large.

In a 2008 U.S. State Department cable alleged that Siva was part of a Seychellois “business mafia” that was buying land from the Seychelles government at the expense of a battered and hopelessly corrupt national economy—this, as the nation was seeking bailouts from the International Monetary Fund and World Bank.

Designed by Rachel Gold

Designed by Rachel Gold

California Out of Coal

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California Governor Jerry Brown has had a busy week.  California pension funds will no longer invest in coal,  a big step forward to a better environment.

The new law will affect $58 million held by the California Public Employees’ Retirement System and $6.7 million in the California State Teachers Retirement System, a tiny fraction of their overall investments. The funds are responsible for providing benefits to more than 2.5 million current and retired employees.

De León pitched the measure as a way to emphasize more secure, environmentally friendly investments.

“Coal is a losing bet for California retirees and it’s also incredibly harmful to our health and the health of our environment,” he said in a statement.

In response to the news, executive director of 350.org May Boeve, whose group has led the charge for institutional divestment, championed the effort in California.

“This is a big win for our movement, and demonstrates the growing strength of divestment campaigners around the world,” said Boeve. “California’s step today gives us major momentum, and ramps up pressure on state and local leaders in New York, Massachusetts, and across the U.S. to follow suit—and begin pulling their money out of climate destruction too.”

Jerry Brown Ends Coal Investment

Megabucks and US Politics

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In the US, money flows freely into the political arena.   Citizens who object to this river work to overcome a Supreme Court decision that corporations are people.  It seems to the editors of this website that we would be better off shortening the political season and making politics open to all comers.  Newton Minow, who was head of the FCC, suggested free media time   Shortening the season would also help.  Turns out currently 158 families are contributing astronomical sums, most of them to Republican candidates.

Nicholas Confessore, Saran Cohen and Karen Yourishoct write:  Donors are overwhelmingly white, rich, older and male, in a nation that is being remade by the young, by women, and by black and brown voters. Across a sprawling country, they reside in an archipelago of wealth, exclusive neighborhoods dotting a handful of cities and towns. And in an economy that has minted billionaires in a dizzying array of industries, most made their fortunes in just two: finance and energy.

Now they are deploying their vast wealth in the political arena, providing almost half of all the seed money raised to support Democratic and Republican presidential candidates. Just 158 families, along with companies they own or control, contributed $176 million in the first phase of the campaign, a New York Times investigation found. Not since before Watergate have so few people and businesses provided so much early money in a campaign, most of it through channels legalized by the Supreme Court’s Citizens United decision five years ago.

These donors’ fortunes reflect the shifting composition of the country’s economic elite. Relatively few work in the traditional ranks of corporate America, or hail from dynasties of inherited wealth. Most built their own businesses, parlaying talent and an appetite for risk into huge wealth: They founded hedge funds in New York, bought up undervalued oil leases in Texas, made blockbusters in Hollywood. More than a dozen of the elite donors were born outside the United States, immigrating from countries like Cuba, the old Soviet Union, Pakistan, India and Israel.

But regardless of industry, the families investing the most in presidential politics overwhelmingly lean right, contributing tens of millions of dollars to support Republican candidates who have pledged to pare regulations; cut taxes on income, capital gains and inheritances; and shrink entitlement programs. While such measures would help protect their own wealth, the donors describe their embrace of them more broadly, as the surest means of promoting economic growth and preserving a system that would allow others to prosper, too.

Mega donors to US politicians

Mega donors to US politicians

Finding A Place for China in TPP

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China belongs in the TPP.

The Bloomberg editorial board writes:  Some are hailing the 12-nation Trans-Pacific Partnership free-trade agreement as a win for American leadership and a defeat for China. Complacency of that kind is shortsighted — and the suggestion that China should be prevented from joining the system in future, which seems to follow, is not just myopic but blind.

Bringing China into the TPP will take time and won’t be easy, but it would serve everybody’s interests. It isn’t too soon to start planning for that goal.

U.S. President Barack Obama has rightly been careful to leave the door open. Next, it’s true, he faces a difficult selling job in Congress — and that task wouldn’t have been any easier if China had already been part of the deal. Nonetheless, a TPP without China would be a huge missed opportunity.

A careful study has estimated that widening the TPP from 12 to 17 countries — adding China, Indonesia, South Korea, the Philippines and Thailand — would triple the deal’s global benefits. Bringing in China, the world’s biggest trading nation, would further strengthen the TPP’s promise as the template for an even wider global agreement.

For all the focus on trade in manufacturing, the biggest potential for gains may lie in services. China’s services sector is one of the world’s most restricted, and a lowering of those barriers would benefit U.S. suppliers handsomely. (According to one estimate, they’d gain another $218 billion by 2025.) China would get better access to the U.S. market in return. More important, though, liberalizing China’s trade in services would hasten the reform of its domestic services providers, dominated today by inefficient state-owned companies jealous of their privileges.

That’s exactly why many Chinese reformers want their country to join the TPP. Efforts at reform have lost momentum lately, with good progress seen in less than a quarter of the 113 areas designated by Beijing. Ring-fenced experiments such as the Shanghai free-trade zone haven’t delivered as hoped. The TPP’s requirements would encourage the government to pick up the pace. The result would be a more productive and stable Chinese economy — good for everyone.

Beijing is discovering the limits of going its own way. Its efforts to set up a regional free-trade agreement without the U.S. are looking less promising. Its new infrastructure bank won’t do much to promote reform at home. Its “one belt, one road” scheme to build infrastructure linking China to the Middle East and Europe offers less potential than greater access to U.S. and Japanese markets.

A TPP that advances the cause of Chinese economic reform and at the same time binds the country into a rule-based multilateral order would be quite a prize. It’s a challenge for China’s leaders, to be sure. They should be given every encouragement to rise to it.

China Into TPP?

Does the US Need to Restore Glass Steagall?

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Hillary Clinton, the leading Democratic contender as the party’s nominee for President, came out with two proposals to make big banks safer.  One is the tax high speed trading.  The other, to hold bank executives accountable for crimes committed by underlings on their watch.

Paula Dwyer writes: Hillary Clinton has a wide-ranging plan to make Wall Street safer. It would make bankers defer some of their compensation so that it could be recovered later if their activities lead to losses that blow up the bank.

Increasing the statute of limitations on financial crimes to 10 years from six is legitimately hard-nosed, as are her proposals to hold bank executives accountable when subordinates break the law, and to beef up the budgets of agencies that police the markets.

The dozens of recommendations, though, seem designed to avoid having to reinstate the Glass-Steagall Act, the Depression-era law that separated commercial from investment banking. To call for Glass-Steagall’s comeback would create a big stink.

In this she risks achieving little and, in some cases, causing harm. This is especially true for her two biggest and most interesting ideas — a so-called risk fee on the largest banks and a tax on high-speed traders.

Her aim is to make these too-big-to-fail banks think twice about using leverage, peddling derivatives, packaging subprime mortgages into bonds, and the like. The problem is that this annual fee would come out of a bank’s capital (money raised from the sale of stock and retained profits). Regulators, however, should want banks to have as much capital as possible to absorb losses, in the way that a homeowner with 20 percent equity in a house wouldn’t be under water even if the home’s market value suddenly declined by 10 percent.

If Clinton really wanted to make the financial system safer, she would require banks to have more capital, making failure less likely in the first place. Instead, a bank could interpret payment of its risk fee as a license to behave in an even riskier manner.

Companies are trying to shave thousandths of a second off trading times, in part by putting their computer servers next to stock-market servers to reduce data-transmission times. High-speed traders use complex algorithms to place billions of buy and sell orders to sniff out demand and profit on split-second changes in price.

Meanwhile, traders cancel many more orders than they complete. Some traders have no intention of actually buying or selling the shares behind their orders, but are just probing the market. There are no real penalties for this strategy, although the Securities and Exchange Commission occasionally goes after trading strategies it finds especially abusive.

High-speed trading has also left the impression that markets aren’t fair or safe for ordinary investors.

Clinton obviously agrees, yet her solution is too blunt an instrument. Her tax would apply only to those with “excessive levels” of canceled orders. She doesn’t define excessive, possibly because it’s an impossible line to draw.

Many of Clinton’s fellow Democrats would prefer that she keep it simple and bring back Glass-Steagall. Her many supporters on Wall Street hate that idea, so her alternative proposals allow her to protect that part of her donor base while defending her husband’s legacy — all while signaling to voters that she’s no pushover. That might work politically — at the cost of getting anything done.

making-banks-accountable-cartoon

US Plays Catch Up on Digital Privacy

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California’s governor Jerry Brown has signed into law the most sweeping and stringent digital privacy law in the country on Thursday.

The American Civil Liberties Union called it a “landmark victory for digital privacy.”

In essence, the law requires a warrant before any business turns over any of its clients’ metadata or digital communications to the government.

Wired reports:

“State senators Mark Leno (D-San Francisco) and Joel Anderson (R-Alpine) wrote the legislation earlier this year to give digital data the same kinds of protection that non-digital communications have.

“‘For what logical reason should a handwritten letter stored in a desk drawer enjoy more protection from warrantless government surveillance than an email sent to a colleague or a text message to a loved one?’ Leno said earlier this year. ‘This is nonsensical and violates the right to liberty and privacy that every Californian expects under the constitution.’

“The bill enjoyed widespread support among civil libertarians like the American Civil Liberties Union and the Electronic Frontier Foundation as well as tech companies like Apple, Google, Facebook, Dropbox, LinkedIn, and Twitter, which have headquarters in California. It also had huge bipartisan support among state lawmakers.”

The ACLU said it hopes the California Electronic Communications Privacy Act becomes a model for other states.

Under the federal Electronic Privacy Communication Act, the government can access digital data using a subpoena instead of a warrant. The paper adds:

“While federal agencies and the Justice Department say they don’t use the authority because of prior case law, technology companies say it creates uncertainty as they try to repair customer trust after the 2013 U.S. surveillance leaks from Edward Snowden.

“In Congress, legislation to updated the act has more than 300 cosponsors, but it has not received any committee or floor action in either chamber.”

DIgital Privacy