Beijing takes first step to regionalise yuan

Business Times - 12 Feb 2009

Beijing takes first step to regionalise yuan

(SINGAPORE) While cynics scoff at the idea that the yuan could some day become a regional or global currency, China's efforts to push loans and trade in yuan in Asia suggest it is taking the first, albeit tiny, step in that direction.

The yuan's journey from a controlled, partially convertible currency to a liquid, regional medium of exchange will be a long one, reflecting the government's desire to uphold economic stability above all else.

Also, Beijing has always been wary of moving too quickly to open up its markets fearing that may leave the economy vulnerable to sudden shifts in capital.

Still, for now, it is testing the waters. Last December, China said the yuan could be used for the settlement of trade between the industrial areas of the Pearl River Delta and Yangtze River Delta and the Chinese territories of Hong Kong and Macau. And Asean members would be permitted to use yuan in their trade with China's southeast provinces of Guangxi and Yunnan.

'This is a fascinating development and clearly part of Beijing's ambition to regionalise the yuan and to help local trading companies,' said Stephen Green, Standard Chartered Bank's China research head.

China has offered cheap loans to foreign importers who buy Chinese goods. Most of these borrowers are now compelled to use the yuan to settle their loans with China.

The Chinese government has also urged banks to offer more cheap yuan loans to foreign firms. State-owned Export-Import Bank extended a US$200 million loan to Myanmar in January to pay for imports of equipment from China to build a power station.

The bank offered US$4.6 billion in such loans to foreign firms to buy Chinese goods from 1994 to 2007.

'This is good to help educate regional traders about the yuan and give them a chance to get familiar with the currency,' Mei Xinyu, a researcher for the Chinese Commerce Ministry, said.

Beijing has said these efforts are geared towards promoting the country's international trade and helping Chinese companies limit their currency exposure, while giving foreign firms a chance to familiarise themselves with the yuan.

'Making the yuan a regional currency will serve China well,' said Zhang Bin, an analyst at the Chinese Academy of Social Sciences, a key government think-tank.

'It can reduce the troubles of managing huge foreign exchange reserves. And, looking forward, it will eventually give China more power in the financial market to match its economic size and foreign exchange reserve levels,' Mr Zhang said. China's US$2 trillion foreign reserves, the world's largest, are mainly held in dollar assets, such as in US Treasuries.

Wu Xiaoling, a parliamentarian and former central bank deputy governor, wrote in a recent edition of the financial magazine Caijing that, for now, there is no substitute for the dollar as the main international currency.

'However, from a long- term perspective, the world should have more choices. And the yuan can possibly become one of them as long as we make good preparations on the economic and financial fronts,' she wrote.

However, releasing the reins significantly on the closely managed currency could prove far more difficult for a government that puts economic stability above all else. The more the yuan moves offshore, the more that companies using it will want access to hedging markets to manage their currency exposure and trading risks.

Until there are active hedging markets, such as swaps and futures markets, companies offshore might remain lukewarm about adopting the yuan\. \-- Reuters

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• FEBRUARY 10, 2009, 11:11 P.M. ET

Reaganomics vs. Obamanomics

The current president wants higher taxes, more regulation, more spending and loose money.

By PETER FERRARA

In his inaugural address, President Barack Obama said, "The question we ask today is not whether our government is too big or too small, but whether it works -- whether it helps families find jobs at a decent wage, care they can afford, a retirement that is dignified." Or as administration spokeswoman Stephanie Cutter said in January, the touchstone is, "What will have the biggest and most immediate impact on creating private sector jobs and strengthening the middle class? We're guided by what works, not by any ideology or special interests."

Corbis

Ronald Reagan and Paul Volcker, July 1981.

Unfortunately, this rhetoric is not true. Mr. Obama's economic policy is following not what has been proven to work but liberal ideology.

The best way to understand this is to compare what's being proposed now with what Ronald Reagan accomplished. In 1980, amid a seriously dysfunctional economy, Reagan campaigned for president on an economic recovery program with four specific components.

The first was across-the-board reductions in tax rates to provide incentives for saving, investment, entrepreneurship and work. The second component was deregulation to remove unnecessary costs on the economy. In today's world, that would especially mean removing the onerous restrictions on energy production -- allowing drilling offshore and onshore for oil and natural gas, revival of the nuclear power industry, and construction of more electric power plants.

Third was the control of government spending. In 1981, Reagan forced through Congress not only his famed, historic tax cuts, but also a package of budget cuts close to 5% of the federal budget -- equivalent to roughly $150 billion today. In constant dollars, nondefense discretionary spending declined by 14.4% from 1981 to 1982, and by 16.8% from 1981 to 1983. Moreover, in constant dollars, this nondefense discretionary spending never returned to its 1981 level for the rest of Reagan's two terms. By 1988, this spending was still down 14.4% from its 1981 level in constant dollars.

Even with the Reagan defense buildup, which helped win the Cold War, total federal spending declined to 21.2% of GDP in 1989 from 23.5% of GDP in 1983. That's a real reduction of 10% in the size of government relative to the economy.

The fourth component of the Reagan recovery plan was tight, anti-inflation monetary policy, which was spectacularly successful. Inflation was cut in half to 6.2% in 1982 from 13.2% in 1980, and cut in half again to 3.2% in 1983.

We know such policies work because they turned around in just two years an economy far worse than today's. We were suffering from multiyear, double-digit inflation, double-digit unemployment, double-digit interest rates, declining incomes, and rising poverty. In fact, what we suffer with today is not the worst economy since the Great Depression, but the worst economy since Jimmy Carter -- the last time liberals were dominant politically and intellectually.

The Obama administration's economic policies do not include any of the four Reagan components. In fact, the stimulus plan is the greatest increase in government spending in the history of the planet. Meanwhile, the Fed is furiously reinflating, sowing more havoc down the line. Mr. Obama is still promising future increases in tax rates by letting the Bush tax cuts lapse, because for ideological reasons he thinks even current rates are too low. And instead of deregulating for more energy production, he is still promising massive increases in regulatory barriers -- through global warming cap-and-trade legislation -- to increased production from proven energy sources to serve an extreme environmentalist ideology.

This is why America seems so hopeless right now, and so depressed. We are stuck going in exactly the wrong direction on economic policy because of currently dominant ideological fashions.

A natural economic recovery will begin sometime this year, not because of the president's policies, but because soon this will be the longest recession since World War II. However, thanks to the administration's retrograde policies -- cut from the cloth of the 1970s and even the 1930s -- the recovery will not be what it should be. Rather, unemployment will remain too high, and inflation will resurge, recreating the disastrous economic results we suffered the last time Keynesian policies were dominant.

Mr. Ferrara is director of entitlement and budget policy for the Institute for Policy Innovation. He served in the White House Office of Policy Development under President Reagan.

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• FEBRUARY 3, 2009, 12:23 P.M. ET

How to Value Toxic Bank Assets

The government and banks can share in any upside

By ROBERT C. POZEN

The Obama administration is reportedly developing a plan to buy from U.S. banks some of their "toxic" assets -- troubled debt securities backed by subprime mortgages or complex derivatives. Many commentators agree that banks will not ramp up their lending until these assets are taken off their balance sheets.

However, the purchase of these securities faces a major challenge -- no one really knows how they should be priced since most have not traded for six months, a long time. Although the Treasury department could hire experts to estimate their prices by methods like discounted cash flow, these estimates would be educated guesses with considerable margin for error.

The pricing challenge is politically explosive. If Treasury pays too much for these assets, Congress and taxpayers will protest. If the prices offered by the Treasury are too low, the banks won't sell.

Here's a practical solution: After making its best estimate of an asset's current value, Treasury should offer the bank a cash payment equal to 80% of that value. For the remaining 20%, Treasury should provide the bank with a capital certificate, which would count as common stock in determining whether the bank meets its capital requirement.

The certificate will also entitle the bank to 80% of the actual price at which the asset is later sold by the government -- but only to the extent that the actual price exceeds the initial cash payment.

For example, suppose the Treasury estimates that a toxic asset is worth $700,000. It would pay the bank $560,000 in cash plus a capital certificate for $140,000.

If the government later sold that security for $660,000, the bank would receive an additional cash payment of $80,000 (80% of $100,000, the excess of $660,000 over $560,000). The Treasury would receive the remaining $20,000 of the excess.

On the other hand, if the government later sold the security for $550,000, the bank would receive nothing more. The Treasury would absorb a loss of $10,000.

This pricing plan should stimulate more lending by banks since they will immediately have cash on hand, instead of an illiquid toxic asset. Banks will also have the chance to receive more cash in the future if the toxic asset is sold at a price above the initial cash payment. In the interim, the capital certificate will help prevent the bank from becoming insolvent, since it will preserve the bank's capital for regulatory purposes.

The plan should also help banks sell new stock to institutional investors, instead of relying entirely on capital infusions from the Treasury. Institutional investors will not buy a bank's stock if they are worried that it will later announce large write-downs of its toxic assets. Now Treasury would effectively be setting a floor on the price of the asset equal to 80% of its estimated value.

Investors will rely on this floor in buying new stock from the bank. They will heavily discount the potential for payments on the subsequent sale of the asset.

Most importantly, the plan would be good for American citizens. They would benefit from more lending by banks, and more private investment in bank stocks instead of government capital infusions.

By limiting the initial cash payment to 80% of an asset's estimated value, the Treasury would be protecting taxpayers from overpaying in most cases. And the Treasury would periodically earn a commission for taxpayers by selling the toxic asset for more than its initial cash payment to the bank.

This plan would allow the government to remove toxic assets from the balance sheets of banks without having to nationalize or liquidate the banks. Under either of these alternatives, U.S. taxpayers would own all the toxic assets of these banks. Although the method of pricing proposed here is not perfect, it is better than these alternatives.

Mr. Pozen is chairman of MFS Investment Management.

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• FEBRUARY 3, 2009, 8:45 A.M. ET

What Other Financial Crises Tell Us

The lesson of history is grim: Expect a prolonged slump

By CARMEN M. REINHART and KENNETH S. ROGOFF

Perhaps the Obama administration will be able to bring a surprisingly early end to the ongoing U.S. financial crisis. We hope so, but it is not going to be easy. Until now, the U.S. economy has been driving straight down the tracks of past severe financial crises, at least according to a variety of standard macroeconomic indicators we evaluated in a study for the National Bureau of Economic Research (NBER) last December.

In particular, when one compares the U.S. crisis to serious financial crises in developed countries (e.g., Spain 1977, Norway 1987, Finland 1991, Sweden 1991, and Japan 1992), or even to banking crises in major emerging-market economies, the parallels are nothing short of stun

Let's start with the good news. Financial crises, even very deep ones, do not last forever. Really. In fact, negative growth episodes typically subside in just under two years. If one accepts the NBER's judgment that the recession began in December 2007, then the U.S. economy should stop contracting toward the end of 2009. Of course, if one dates the start of the real recession from September 2008, as many on Wall Street do, the case for an end in 2009 is less compelling.

On other fronts the news is similarly grim, although perhaps not out of bounds of market expectations. In the typical severe financial crisis, the real (inflation-adjusted) price of housing tends to decline 36%, with the duration of peak to trough lasting five to six years. Given that U.S. housing prices peaked at the end of 2005, this means that the bottom won't come before the end of 2010, with real housing prices falling perhaps another 8%-10% from current levels.

Equity prices tend to bottom out somewhat more quickly, taking only three and a half years from peak to trough -- dropping an average of 55% in real terms, a mark the S&P has already touched. However, given that most stock indices peaked only around mid-2007, equity prices could still take a couple more years for a sustained rebound, at least by historical benchmarks.

Turning to unemployment, where the new administration is concentrating its focus, pain seems likely to worsen for a minimum of two more years. Over past crises, the duration of the period of rising unemployment averaged nearly five years, with a mean increase in the unemployment rate of seven percentage points, which would bring the U.S. to double digits.

Interestingly, unemployment is a category where rich countries, with their high levels of wage insurance and stronger worker protections, tend to experience larger problems after financial crises than do emerging markets. Emerging market economies do have deeper output falls after their banking crises, but the parallels in other areas such as housing prices are quite strong.

Perhaps the most stunning message from crisis history is the simply staggering rise in government debt most countries experience. Central government debt tends to rise over 85% in real terms during the first three years after a banking crisis. This would mean another $8 trillion or $9 trillion in the case of the U.S.

Interestingly, the main reason why debt explodes is not the much ballyhooed cost of bailing out the financial system, painful as that may be. Instead, the real culprit is the inevitable collapse of tax revenues that comes as countries sink into deep and prolonged recession. Aggressive countercyclical fiscal policies also play a role, as we are about to witness in spades here in the U.S. with the passage of a more than $800 billion stimulus bill.

Needless to say, a near doubling of the U.S. national debt suggests that the endgame to this crisis is going to eventually bring much higher interest rates and a collapse in today's bond-market bubble. The legacy of high government debt is yet another reason why the current crisis could mean stunted U.S. growth for at least five to seven more years.

Yes, there are important differences between the current U.S. crisis and past deep financial crises, but they are not all to the good. True, for the moment the U.S. government is in the very fortunate position of being able to borrow at lower interest rates than before the crisis, and the dollar has actually strengthened. Still, deep financial crises in the past have mostly been country-specific or regional, allowing countries to export their way out.I

The current crisis is decidedly global. The collapse in foreign equity and bond markets has inflicted massive losses on the U.S. external asset holdings. At the same time, weak global demand limits how much the U.S. can rely on exports to cushion the ongoing collapse in domestic consumption and investment.

Can the U.S. avoid continuing down the deep rut of past financial crises and recessions? At this point, effective policy prescriptions -- such as coming up with realistic costs of the size of the hole in bank balance sheets -- require a sober assessment of where the economy is going.

For far too long, official estimates of the likely trajectory of U.S. growth have been absurdly rosy and always behind the curve, leading to a distinctly underpowered response, particularly in terms of forcing the necessary restructuring of the financial system. Instead, authorities should be prepared to allow financial institutions to be restructured through accelerated bankruptcy, if necessary placing them under temporary receivership, and only then recapitalizing and reprivatizing them. This is not the time for the U.S. to avoid painful but necessary restructuring by telling ourselves we are different from everyone else.

Ms. Reinhart is professor of economics at the University of Maryland. Mr. Rogoff is professor of economics at Harvard and former chief economist at the International Monetary Fund.

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China: Policy can't change saving habit overnight

Business Times - 11 Feb 2009

Policy can't change savings habit overnight: China

(KUALA LUMPUR) China's central bank chief yesterday played down hopes in the West that a drive by China to save less and spend more might help revive flagging global growth.

China's sky-high savings rate is a function of deep-rooted social and cultural factors that cannot be addressed overnight by economic policies, said Zhou Xiaochuan, the governor of the People's Bank of China.

Speaking at a central bank conference in Kuala Lumpur, Mr Zhou acknowledged that China's domestic savings rate - 49.9 per cent of gross domestic product at the end of 2007 - was too high. But he said that it would take a long time to reduce the rate.

'If we need to change some policies, it may be a slow process, especially when you want to change national traditions, cultural impacts, family structures and demographics,' he said.

Washington, in particular, has long urged China to help restore balance to the global economy by taking steps to reduce savings.

Because China does not have a sturdy social safety net, households save about 30 per cent of their disposable incomes to meet out-of-pocket medical and education bills and other expenses. As a result, household consumption has been falling steadily in recent years and accounted for just 35.3 per cent of gross domestic product in 2007, a record low for a major economy in peace-time.

Corporate savings have also ballooned since state-owned firms were largely relieved a decade ago of their obligation to provide cradle-to-grave welfare. State-run companies also pay minimal dividends to the central government.

Premier Wen Jiabao recently rejected as ridiculous the idea that countries such as China with low savings rates should be blamed for the economic imbalances at the root of the global malaise.

But China has been steadily introducing measures to promote consumption. It has extended nationwide, a pilot programme that gives farmers a discount when they buy electrical appliances.

The government approved plans last month to spend 850 billion yuan (S$186 billion) over the next three years to ensure basic health care coverage. And the Commerce Ministry said on Monday that it hopes to create 450,000 jobs this year by providing incentives to open rural stores. As well as seeking to boost consumption in rural areas, Mr Zhou said that China had been trying to reduce domestic savings by adjusting exchange and interest rates and by developing its financial markets. But he said that it was not realistic to expect immediate results.

He cited the landmark shift to its exchange rate regime in July 2005, when China abandoned a long-standing peg to the dollar, and said that the yuan would be allowed to float within managed bands.

'We tried to lower excessively high expectations that the exchange rate regime reform would solve these problems,' he said.

With China saving more than it can invest, it ran a current account surplus that exceeded 7 per cent of GDP last year.

The bulk of those excess savings are recycled into US Treasury bonds and other dollar assets, mainly by the central bank, but Mr Zhou said that China needed to look at putting some of its money elsewhere. 'Shouldn't China consider sending its savings to those places like Africa rather than concentrating too much on the United States?' he said, without offering a timeframe or specifics\. \-- Reuters

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Asia Pledges to stimulate economies

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FACTBOX-Asia pledges to stimulate economies 26 Nov 2008 15:10

(For related story see [ID:nHKG394570]) Nov 26 (Reuters) - Asian and Australasian governments have pledged hundreds of billions of dollars in fiscal stimulus plans, ranging from tax cuts to shopping vouchers, to lessen the impact of the global financial crisis on their economies. Here are some details on some of the main packages. Click on the codes in brackets for full stories. AUSTRALIA: * Nov 10: A$3.4 billion ($2.3 billion) package for the auto industry to offset crisis and a 2010 tariff cut. [ID:nSYD415429] * Oct 14: A$10.4 billion ($6.8 billion) package of cash handouts and family benefits; an additional A$1.5 billion ($978 million) to boost housing and home building markets, grant for first-time home buyers doubled to A$14,000. [ID:nSYD391388] * Sept 26: Government to invest $A4 billion ($3.33 billion) in domestic residential-backed mortgage market (RMBS). [ID:nSYD365120]. It doubles the amount to A$8 billion a few weeks later. CHINA: * Nov 14: Value added tax (VAT) rule change allows companies to deduct the cost of core investment expenses, saving them about 120 billion yuan a year. [ID:nSHA293184]. The government has also increased export tax rebates for a wide range of products. * Nov 9: A 4 trillion yuan ($586 billion) stimulus package to boost domestic demand through 2010, 100 billion yuan of which will be spent by the central government by the end of 2008. Central government to finance 1.18 trillion; the rest from local governments and state-owned banks and enterprises. [ID:nPEK71029] HONG KONG: * Nov 10: A 70 percent guarantee of loans to SMEs and a HK$10 billion ($1.3 billion) pledge of extra liquidity for loans to SMEs. [ID:nHKG73224] JAPAN: * Oct 30: A 5 trillion yen ($51 billion) package of new government spending, including 2 trillion yen in payouts to families, tax breaks on mortgages. [ID:nT214217] [ID:nT239177] MALAYSIA: * Nov 4: 7 billion ringgit ($2 billion) injection into 2009 budget from fuel subsidy savings, cut employees' pension fund contribution to 8 percent from 11 percent, allow foreigners to hold up to 70 percent in services firms in 2015. [ID:nKLR205233] * Aug 22-Nov 17: Five fuel price cuts since June. SOUTH KOREA: * Nov 3: A 14 trillion won ($11 billion) government stimulus package; additional 3 trillion won in tax cuts. [ID:nSEO370901] * Sept 18: A 4.57 trillion won ($3 billion) supplementary budget for 2008, to ease impact of high oil prices. [ID:nSEO82676] * June 8: 10.5 trillion won ($10.2 billion) package to ease financial burden of surging oil prices. [ID:nSEO281176] -- For a more detailed list see FACTBOX-South Korea measures to stave off crisis [ID:nSEO7274] THAILAND: * Oct 30: Government to boost public spending by 100 billion baht ($2.9 billion) to 1.94 trillion baht. [ID:nBKT000830] * July 16: A 46 billion baht ($1.3 billion) package of tax cuts and handouts for the poor, including cuts in transport and utility costs. [ID:nBKK261585] TAIWAN: * Nov 18: A T$83 billion ($688.6 million) shopping voucher handout -- about T$3,600 ($108) per citizen, to boost domestic consumption. Scheme needs parliamentary approval for a 2009 start. [ID:nTP274071] * Sept 11: Stimulus package to generate T$1 trillion ($30 billion) in domestic investment and consumption. Steps include T$122.6 billion in subsidies and tax cuts and T$58.3 billion in infrastructure spending. [ID:nTP277349] -- For a FACTBOX on global fiscal stimulus plans to tackle the crisis see [ID:nLN444507] (Compiled by Gillian Murdoch; Editing by Neil Fullick) ((gill.murdoch@reuters.com, +65 6870 3922, Reuters Messaging gill.murdoch.reuters.com@reuters.net)) Keywords: FINANCIAL/ASIA STIMULUS

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Where the money goto

U.S. Credit Crisis

Where the money will go ($250 billion)

Citigroup J.P. Morgan Bank of America Merrill Lynch Goldman Sachs Morgan Stanley State Street Bank Bank of New York

$25 billion $25 billion $12.5 billion $12.5 billion $10 billion $10 billion $3 billion $3 billion

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