coming from Japan’s opposition party — which isn’t exactly steaming ahead towards victory

TO BE NOTED: From Alphaville:

"Samurai-ed: Japan ‘would avoid dollar bonds’ Posted by Tracy Alloway on May 13 10:12.

Japan voiced some anti-dollar/US Treasuries remarks and a future preference for samurai bonds late Tuesday.

From the BBC:
Japan’s opposition party says it would refuse to buy American government bonds denominated in US dollars, if elected.

The chief finance spokesman of the Democratic Party of Japan, Masaharu Nakagawa, told the BBC he was worried about the future value of the dollar. Japan has been a major buyer of US government bonds, helping the US finance its Federal budget deficits.

But, he added, it would continue to buy bonds only if they were denominated in yen - the so-called samurai bonds.

Yen-denominated bonds would effectively mean that the US is exposed to the risk of future falls in the value of the USD rather than Japan. That’s a pretty big policy shift for Nippon, which has been a strong buyer of US Treasuries - and, taken with comments coming out of China, hints at a growing unease in Asia over the USD’s supremacy.

But, as the BBC story notes, this is coming from Japan’s opposition party — which isn’t exactly steaming ahead towards victory. Nakagawa’s comments have also been toned down since his interview with the BBC, and there is, as often happens with Japanese politics, undoubtedly a dose of anti-gaijin political rhetoric in the above. BarCap has a good summary:
Masaharu Nakagawa, the “shadow” finance minister of Japan’s largest opposition party, the Democratic Party of Japan, was quoted by BBC on 12 May saying that his party would shun buying US bonds denominated in dollars if his party took the reins of government as a result of Japan’s upcoming lower house election. In an interview with Bloomberg News on 13 May, however, Mr. Nakagawa clarified that it would merely be one option for Japan to propose that the US government issue samurai bonds (US bonds denominated in yen), and that this was strictly his personal proposal and would not necessarily be implemented immediately by the party if it took the helm. The comments, while perhaps reflecting a genuine concern shared by other world leaders, would also serve to boost Mr. Nakagawa’s nationalist credentials ahead of the election and, we believe, should be viewed primarily in that context. Japan’s lower house election must be held by this September, but could be called earlier if the prime minister decides to dissolve the lower house prior to that time.

The samurai will be waiting for a while, it seems.

Related links:
Samurai bond market revives - FT
China to US: We hate you - FT Alphaville
We ‘hate you guys’ even more now… - FT Alphaville

This entry was posted by Tracy Alloway on Wednesday, May 13th, 2009 at 10:12 and is filed under Capital markets, People. Tagged with china, Dollar, japan, Treasuries, yen."

the fear of losses meant that even countries with ample liquidity seem to have moved into the Treasury market, adding to the pressure elsewhere

From Follow The Money:

"The reserve manager panic of 2008 …

Posted on Friday, May 1st, 2009

By bsetser

Yes, my headline is a bit overstated. Panic is too strong. A sudden stop might be a better term. or an (almost) orderly withdrawal. But there is more and more data suggesting that central bank reserve managers added to the stress in the credit markets during the crisis of the fall of 2008.

We have known for a long-time that some central banks shifted from buying huge quantities of US Agency bonds (Fannie, Freddie and the like) to selling fairly large quantities rather suddenly. Big buyers in the second quarter of 2008 were big sellers in the fourth quarter of 2008. And we now know that the world’s reserve managers pulled a fair amount of liquidity out of the international banking system in the fourth quarter as well.

The BIS data (table 5c) suggests that central banks pulled about $200 billion ($192.6 billion to be exact, summing “domestic” and “foreign” currency liabilities to monetary authorities) from the world’s big banks in the fourth quarter. Their euro deposits fell too, by almost $60 billion ($57.6 billion). That no doubt added to the pressure on the dollar liquidity of Europe’s banks: US money market funds and the world big central banks were pulling dollars out simultaneously.

The Fed and Europe’s central banks filled the breach, with their swap lines.

To be clear, when a country’s reserves fall, it has to run down its foreign assets — whether its holdings of Treasuries, its holdings of Agencies or its deposits with large banks. Emerging economies that ran down their reserves to — in effect — finance either capital outflows from their own country or to cover a current account deficit were helping to stabilize the system.

Think of it this way: some central banks ran down their deposits in the world’s banks to help their private banks repay the same international banks. That is stabilizing.

However, that wasn’t all that was going on. Global reserves were down by around $200 billion (my estimate, based on the COFER data) in q4, and dollar reserves were down something like $150 billion.

But central banks pulled close to $200 billion out of the big banks and another $150 billion or so out of the Agency market. That is a roughly $350 billion outflow …

So where was the money going? We know the answer: into short-term Treasuries. The Fed’s custodial holdings of Treasuries increased by $250 billion in q4.

I understand fully why reserve managers did this. Their core mandate is to make sure that their country has enough safe, liquid foreign assets to meet their country’s needs — and they over-estimated the safety and liquidity of some key assets. But the net effect of their actions was still destabilizing. They were pulling large amounts of dollar liquidity out of troubled financial institutions that were short of dollar liquidity.

Absent intervention by the Fed, the Treasury and a host of European central banks, a lot more illiquid financial institutions would have failed.

To be sure, emerging market central banks have at times played a stabilizing role in the market. They stepped up their purchases of dollars enormously when private investors’ lost their appetite for dollars in 2006, 2007 and early 2008. That big influx allowed the US to continue to run large current account deficits — and kept the dollar from falling further. Back then central banks were buying the assets private investors were selling. At a micro-level that was stabilizing, though I think a case can be made that at a macro-level it was destabilizing, as it blocked a needed adjustment in the US, and thus stored up future problems.

In the fall of 2008, though, emerging market reserve managers clearly added to the pressures in the credit markets. They moved money out of big banks at the same time private creditors moved money out of big banks. The overall result was destabilizing.

The conclusion that I have drawn is that reserve managers need to hold assets in good times that they are confident that they can continue to hold in bad times. When times were good — and when emerging market central banks were buying huge quantities of dollars to offset a fall in private demand for dollars (and large private inflows into the emerging world) — central banks reached for yield. At the end of the day, though, most reserve managers worry more about losses than returns, and the fear of losses meant that even countries with ample liquidity seem to have moved into the Treasury market, adding to the pressure elsewhere."

Me:

May 1st, 2009 at 5:21 pm
1. Don the libertarian Democrat responds:
   

   I believe that the Flight from Treasuries began after Fannie/Freddie in August. I’ve tried to find out if this is true, and, in the case of China, they did this, unless they perceived a real difference between implicit and explicit guarantees. Oddly, I thought that we were actually telling everyone that we explicitly guaranteed agencies with a wink and a nod. Apparently the Chinese didn’t believe this. Why?

   Geithner has recently been ridiculed for arguing for a complete govt guarantee. I would like to join the club of the ridiculed. We should have explicitly guaranteed Agency/Fannie/Freddie, and saved Lehman.

   The Flight from Risk is a serious issue because of Debt-Deflation. Here’s Martin Feldstein:

   “The resulting unusual economic environment of falling prices and wages can also have a damaging psychological impact on households and businesses. With deflation, we are heading into unknown territory. If prices fall at a rate of 1 percent, could they fall at a rate of 10 percent? If the central bank cannot lower interest rates further to stimulate the economy, what will stop a potential downward spiral of prices? Such worries undermine confidence and make it harder to boost economic activity.”

   A Debt-Deflationary Spiral is terrifying precisely because it has no natural stopping point. Theories which claim that there is one are way too optimistic. The Flight from Agencies was a signal that Debt-Deflation was a possibility. Unless you have a government guarantee behind this possibility, it becomes much more likely, because investors know that only governments have the resources to backstop such a guarantee.

   By the way, the point of the guarantee is not to spend the money, but stop the panic and allow an orderly process of losses.

   China has clearly stated that they believed that our govt had guaranteed these assets, and, since Lehman, have been getting more and more vocal about it. Why then, if that’s true, did they jump the gun in selling agencies in August?

   Finally, I want to reiterate what China has said about QE. According to the Chinese, in the Asian Crisis, they did not resort to QE. They claim that they were “responsible”. I do believe that China is making some headway in convincing the world that they are responsible, while we are not, even as they buy our bonds. To the extent that letting Lehman fail is seen around the world as the cause of this crisis, the US is seen as not being responsible.

And:

May 2nd, 2009 at 8:43 am
1. bsetser responds:
   

   there was a real debate inside the republican party about the logic of bailing out entities like the Agencies, and in the end Paulson offered a halfway house that fell short of complete backing. that apparently wasn’t enough for china. many countries concluded that the political cost of holding agencies (especially fannie and freddie) when the risk that they would need to be bailed out was in the news was also higher than the yield.

   for what it is worth, though, the fed’s custodial holdings of agencies have now stabilized.

One or two of its ageing G20 partners may wish to take a closer look at Chinese economic policy to see how it's done

TO BE NOTED: From the FT:

"China shows the world how to get through a crisis

By Jim O'Neill

Published: April 23 2009 03:00 | Last updated: April 23 2009 03:00

Call me mad but this crisis is good for China. It is also good for China's role and responsibilities in the world.

Yesterday, we upgraded our gross domestic product forecasts for China for 2009 and 2010; we are now looking for 8.3 and 10.9 per cent, respectively, up from 6 and 9 per cent.

Why the optimism? It was clear that the massive rise in exports, the mainstay of the China growth model until 2008, was not sustainable. At one stage in late 2007, Chinese exports to the US alone were about 12 per cent of total GDP. This meant that exports would suffer badly in the event of something going wrong with demand in the US, and the risk of a protectionist backlash.

This led some of us to expect an end to the fixed Rmb8.28 exchange rate to the dollar and a gradual shift to a more flexible, stronger exchange rate a few years ago.

Fast-forward to the crisis. When this intensified post-Lehman, global trade suffered enormously and quickly, and it was clear that Chinese growth would suffer. It was also reasonably clear that, just as they did in response to the Asian crisis in 1997, Chinese policymakers would react swiftly and shift gears. That they have done.

Three policy initiatives stand out, and the results are starting to bear fruit, hence our upgraded forecasts.

First, in November the authorities announced massive fiscal expansion, centred on fresh infrastructure spending. While my industry has quibbled about its true size ever since, this misses the point. The statement of intent was clear; interestingly, the stock market noticed and has rallied since.

Second, and ultimately perhaps the most important development in the world economy, the government announced plans to develop a full medical insurance policy for the still vast rural community, the beginnings of which it plans to have fully implemented for 90 per cent of the rural community by 2011. This could result in an end to the excessively high Chinese savings rate and allow much stronger consumption.

Third, and critical to our forecast upgrade, the authorities, led by the People's Bank of China, embarked on a timely reversal of tightening financial conditions of the previous two years. According to our Chinese financial conditions index, conditions have eased a huge 520 basis points since last October.

These three measures have set the scene for an acceleration of Chinese domestic demand for the rest of 2009 and 2010, just the right recipe for China and, critically, the world.

The next stage of China's development has started and is likely to go on for years. It was partly in anticipation of this that we highlighted owning China "A" shares as one of our most favoured trades for 2009. As they have risen 50 per cent since the November stimulus announcement, the entry point is now less attractive but, as evidence of rising demand accumulates, many investors are rightly going to be attracted back to China.

The "C" in the Bric economies (Brazil, Russia, India, China) has always been the most important of the four and the events of the past five months continue to justify our excitement for the longer term.

Amusingly, in the past year many people have suggested that the Brics story is over. Nonsense - it is still in its infancy. Indeed, the updated longer-term projections we published last summer, suggesting that China could overtake the US by 2027 and that the Brics collectively could be as big as the G7 by 2027, still look decent bets to me.

At some stage in the coming months, once it becomes clear that Chinese GDP growth is safely back above 8 per cent, policymakers will allow for some tightening of financial conditions again, possibly led by the exchange rate.

In the next two years, China is very likely to overtake Japan to become the second-largest economy in the world. Some say that China might get old before it gets rich, but it is getting bigger and richer, that is for sure. One or two of its ageing G20 partners may wish to take a closer look at Chinese economic policy to see how it's done.

Jim O'Neill is chief economist at Goldman Sachs"

"It would be a significant step for China to set a target that directly links carbon emissions to economic growth for the first time,"

TO BE NOTED: From the Guardian:

"China considers setting targets for carbon emissions

Government's decision could help negotiations on a Kyoto successor treaty in Copenhagen

• Jonathan Watts, Asia environment correspondent
• guardian.co.uk, Sunday 19 April 2009 15.27 BST
• Article history

The Chinese government is for the first time considering setting targets for carbon emissions, a significant development that could help negotiations on a Kyoto successor treaty at Copenhagen later this year, the Guardian has learned.

Su Wei, a leading figure in China's climate change negotiating team, said that officials were considering introducing a national target that would limit emissions relative to economic growth in the country's next five-year plan from 2011.

"It is an option. We can very easily translate our [existing] energy reduction targets to carbon dioxide limitation" said Su. "China hasn't reached the stage where we can reduce overall emissions, but we can reduce energy intensity and carbon intensity."

A second government adviser, Hu Angang, has said China should start cutting overall emissions from 2020.

While that is a minority view and final decisions are some way off, the proposals are striking because they are at odds with China's official negotiating stance.

Beijing has hitherto rejected carbon emission caps or cuts, arguing that its priority is to improve its people's living standards – and that the west caused the global warming problem and should fix it. But developed nations argue that they cannot commit to deep cuts and to substantial funding for developing nations to fight climate change unless those countries embrace emissions targets.

Environmental groups and foreign diplomats said a carbon intensity target would be a significant step forward. Any move by China, the world's fastest expanding major economy, biggest emitter of greenhouse gases and most influential developing nation, would have an enormous impact on the outcome of the Copenhagen summit in December.

"It would be a significant step for China to set a target that directly links carbon emissions to economic growth for the first time," said Yang Ailun of Greenpeace.

"This is a green shoot of pragmatism that should be nurtured," said one European diplomat.

Hu, an influential economist and advocate of "green revolution", is pressing the government to take a leadership role in Copenhagen by making a public commitment to reduce emissions, and last week submitted the proposal to set a new carbon dioxide goal.

He is one of 37 members of an elite body that advised the premier, Wen Jiabao, to include ambitious targets of a 20% improvement in energy efficiency and 10% reduction of pollution in the 2006-2010 plan. With government figures suggesting the country is on course to approach or exceed those goals, Hu suggests they be extended for the next plan with the addition of the carbon dioxide target.

If his proposal is accepted, Hu believes China will be able to make an international pledge this year to reduce carbon dioxide emissions from 2020.

His views are several steps beyond the negotiating position of the government and officials on the national development and reform commission (NDRC) are cautious even about goals for energy efficiency. "We are very optimistic to reach the energy intensity target of 20% or so," said Su. "But personally I don't think that we can achieve the same for the next five years as the low-lying fruit is already taken."

He was still more doubtful about Hu's suggestion that China's carbon emissions could start to go down after 2020.

"We are trying to reach the emissions peak as early as possible for the earth and future generations. I cannot give you a specific year, but it's certainly not realistic to say the peak will come in 2020," he said.

But the debate on China's role in greenhouse gas reductions is widening. Last month, the Chinese Academy of Science reported that the country's carbon dioxide emissions relative to GDP should be reduced by 50% by 2020, and that total CO₂ emissions should peak between 2030 and 2040 if the country introduced more stringent energy-saving policies and received more financial support and technology from overseas.

The Brookings Institution, a US thinktank, has pinpointed domestic reductions in emission intensity in China as a possible area of compromise with the US, which has made a greater effort to reach out to Beijing on climate change issues under President Barack Obama. The softening comes amid a flurry of talks between Chinese and US leaders and officials in Washington, London and Bonn.

"The message we have got is that the current US administration takes climate change seriously, that they recognise their historical responsibility and that they have the capacity to help developing countries address climate change," said Su. But he called on the US to go further than Obama's promise to cut emissions to 1990 levels by 2020.

Whether an agreement can be reached before the Copenhagen conference remains to be seen, but the debate inside China is moving into new areas. "Chinese leaders recognise China's responsibility. The question is whether or not they make a public commitment about how much they will do and by when," said Hu.

The urgency is increasing. Citing new figures from the state bureau of energy, Hu said China overtook the US last year as the world's biggest energy producer with 2.6bn tonnes of standard coal equivalent, seven years ahead of expectations. "If we can't succeed in reducing energy consumption, then no one can. I tell the government that a 1% failure in China is a 100% failure for the world," said Hu. "We must satisfy our national interest and match it with the interest of humanity."

“China and the U.S. have a symbiotic relationship,” Thin said. “We need each other.”

TO BE NOTED: From Bloomberg:

"China Bought More U.S. Securities Even Amid Concerns (Update1)

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By Vincent Del Giudice

April 15 (Bloomberg) -- China, the U.S. government’s biggest creditor, increased its purchases of American securities in February just weeks before the country’s officials questioned whether such investments were safe.

While China’s purchases slowed and most were in short-term Treasury bills, the country remained the largest foreign holder of Treasuries after its holdings rose 0.6 percent to $744.2 billion, according to a monthly report released in Washington.

“It still comes down to holding the most valuable stuff,” said Richard Yamarone, chief economist at Argus Research in New York. “If you have a baseball card collection, and times get bad, you don’t sell the Honus Wagner or the Mickey Mantle rookie card,” he said, referring to two of the game’s biggest historical stars. “They have always been, and will always remain, the most desirable holdings.”

Still, the governor of the People’s Bank of China, Zhou Xiaochuan, last month urged the establishment of a “super- sovereign reserve currency” after Chinese Premier Wen Jiabao said he’s “worried” a weaker U.S. dollar may hurt China’s investment. The U.S. needs China to sustain its purchases to fund billions’ worth of programs aimed at reviving the economy, about 70 percent of which reflects consumer spending.

Devil’s Bargain

“If they are going to boost their economy by selling consumer goods to the U.S., accepting U.S. Treasuries is part of their bargain with the devil,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. U.S. Treasury bills, notes and bonds are considered the safest and most liquid, he said, and “February was a big safe- haven buying month given the stock market’s troubles.”

According to an analysis by Win Thin, a senior currency strategist at Brown Brothers Harriman & Co. in New York, today’s report shows “we are not seeing any wholesale dumping of dollar assets by China.”

In an interview, Thin said the smaller increase in holdings of Treasury securities reflects a slowdown in capital flows between investors in China and other emerging markets rather than deliberate efforts on the part of the Chinese authorities.

“China and the U.S. have a symbiotic relationship,” Thin said. “We need each other.”

Foreign Investment

Foreign direct investment into China fell for a sixth month from a year earlier. Investment dropped 9.5 percent to $8.4 billion in March, the Chinese commerce ministry said at a briefing in Beijing today. That marked the first time since 2000 that investment from abroad has fallen for six straight months, according to Bloomberg data.

Worldwide foreign direct investment fell 21 percent last year to $1.4 trillion because of the global recession and falling profits, according to estimates from the United Nations Conference on Trade and Development, and it’s likely to decline further this year, the agency said.

Phone calls and an e-mail message to China’s embassy in Washington were not returned by press time.

Separately today, U.S. Treasury Secretary Timothy Geithner refrained from labeling China as a currency manipulator, backtracking from an assertion he made during his confirmation hearings in January.

In its first semiannual report on foreign-exchange policies since Geithner became secretary, the Treasury said that while the yuan remains “undervalued,” no country “met the standards” for illegal currency manipulation during the period of the report, from July 2008 through December 2008.

The conclusion clashes with Geithner’s January 22 statement to a Senate panel that “President Obama -- backed by the conclusions of a broad range of economists -- believes that China is manipulating its currency.”

To contact the reporters on this story: Vincent Del Giudice in Washington at vdelgiudice@bloomberg.net"

China’s proposals give Asean countries “another option” besides going to the International Monetary Fund or the Asian Development Bank for funding

TO BE NOTED: From Bloomberg:

"China Plans $10 Billion Asean Investment Funding (Update1)

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By Dune Lawrence

April 12 (Bloomberg) -- China plans to create a $10 billion investment cooperation fund and offer $15 billion in credit to its Southeast Asian neighbors, extending its influence as the region attempts to weather the global financial crisis.

The investment fund will promote infrastructure development linking China with the 10 members of the Association of Southeast Asian Nations, while the loans will be offered over three to five years, according to a statement on the Foreign Ministry Web site today citing an interview with Foreign Minister Yang Jiechi.

The measures from the world’s third-largest economy, and one of the few forecast to maintain growth this year, may help speed recovery from the global financial crisis and cement China’s leadership in the region. The nation has already signed currency swap agreements with Indonesia, South Korea, Hong Kong and Malaysia this year to help ease foreign-exchange shortages and aid bilateral trade and investment.

“China is going to take the opportunity of this crisis to further establish itself in Asia,” said Huang Jing, a visiting professor at the National University of Singapore’s Lee Kuan Yew School of Public Policy. “All this will have a huge political and diplomatic impact in the region, in addition to the economic impact.”

Other planned measures include 270 million yuan ($39.5 million) in aid to Cambodia, Laos and Myanmar, and donation of 300,000 tons of rice to an emergency East Asia rice reserve to boost food security, the statement said.

‘Difficult Times’

Premier Wen Jiabao was to announce the proposals at the Asean summit that was canceled in Thailand this weekend.

“Asean leaders hope China could play an important role in pushing forward cooperation in East Asia, and with other countries overcome the difficult times,” Yang said, according to the statement. Wen’s proposals reflect a resolve to “realize the Chinese government’s sincerity, responsibility and confidence in pushing forward Asean cooperation,” he said.

Macquarie Securities Ltd. and China International Capital Corp. estimate that China’s economy will expand as much as 8 percent this year. The World Bank expects 6.5 percent growth.

China’s proposals give Asean countries “another option” besides going to the International Monetary Fund or the Asian Development Bank for funding, Huang said. That may aid China’s standing with Asean, where memories are still fresh of the painful conditions imposed by the IMF in exchange for rescue packages during the 1997-98 Asian financial crisis, according to Huang.

“Southeast Asian countries will welcome the proposal,” he said."

This means fast loan growth will continue. The longer this goes on, though, the bigger the risk of asset bubbles developing becomes

TO BE NOTED: From Bloomberg:

"China Central Bank Pledges Sufficient Liquidity (Update2)

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By Kevin Hamlin and Dune Lawrence

April 12 (Bloomberg) -- China’s central bank said it will ensure sufficient liquidity to sustain economic growth, damping speculation regulators may seek to restrain credit after new loans jumped sixfold to a record in March.

The People’s Bank of China “will implement moderately loose monetary policy and maintain the continuity and stability of policy,” the central bank said on its Web site today. It pledged “ample liquidity” to “ensure money supply and loan growth meet economic development needs.”

The statement indicates that reviving growth remains China’s priority amid concern that the credit boom will lead to bad debts and asset bubbles. The world’s third-largest economy, while showing better-than-expected performance in the first quarter, still faces “great difficulties,” Premier Wen Jiabao told reporters in Thailand yesterday.

“It’s likely that the authorities will not change their stimulative policy at least for another month,” said Stephen Green, head of China research at Standard Chartered Plc in Shanghai. “This means fast loan growth will continue. The longer this goes on, though, the bigger the risk of asset bubbles developing becomes.”

New loans rose to 1.89 trillion yuan ($277 billion) in March, the central bank said yesterday. M2, the broadest measure of money supply, grew 25.5 percent, the most since Bloomberg began compiling data in 1998 and more than the 21.5 percent median estimate in a survey of 12 economists.

Stimulus Effect

China’s industrial production climbed 8.3 percent from a year earlier in March and consumer demand grew “relatively rapidly” in the first quarter, adding to signs that the government’s 4 trillion yuan stimulus plan is taking effect, Wen was cited as saying by the official Xinhua News Agency.

The government has pushed banks to lend in support of the stimulus, implemented after the global recession led to a collapse in exports that dragged economic growth to the weakest pace in seven years. China’s lending boom contrasts with the struggle in the U.S. to rid banks of illiquid assets and efforts by central banks from Switzerland to Japan to unfreeze credit.

China’s banks, which are mostly state-owned, have already met the bulk of the government’s target of at least 5 trillion yuan of new loans this year. Lending may top that level by as much as 3 trillion yuan, according to JPMorgan Chase & Co.

“The biggest dangers to China’s economy and financial system come from within, not from outside,” Jiang Zhenghua, former vice chairman of China’s parliamentary standing committee, said at a conference in Beijing yesterday. “The biggest of these hidden dangers is the degree of bad loans in China.”

Bad Loans

Commercial banks’ bad-loan ratio was 2.45 percent at the end of 2008, according to the regulator. The ratio was more than 20 percent in 2003, before the government completed a cleanup of the banking system that cost more $500 billion.

The China Banking Regulatory Commission asked all banks to raise bad debt provisions to 150 percent of outstanding non- performing loans to be “prudent,” Chairman Liu Mingkang said in Beijing last month.

In today’s statement, the central bank pledged to prevent loans from going to high energy-consuming or polluting enterprises or to industries where there is overcapacity. It also reiterated support for loans to the agricultural sector, as well as to small- and medium-sized companies.

“The lending numbers are extraordinarily strong and there must be concerns about the impact on overall loan quality, the potential for new asset price bubbles, and whether these funds can all be allocated to investment projects in an efficient manner,” said Brian Jackson, senior strategist at Royal Bank of Canada in Hong Kong. “When you are throwing around so much money so quickly, some of it is bound to be wasted.”

Deepening Crisis

The Shanghai Composite Index has climbed 34 percent this year, the second-best performer this year of 88 benchmark gauges tracked by Bloomberg, fueling concern that some of the increase in lending has been used for speculation.

“Some of the money has gone to the property market, some to the stock market,” said Kevin Lai, an economist with Daiwa Institute of Research in Hong Kong. “It is not what the central bank wants to see.”

Wen cited a month-on-month rebound in trade and gains in stocks and property transactions as evidence the stimulus is working, in an interview at the aborted Association of Southeast Asian Nations meeting, according to Xinhua. Signs of recovery also include a 26.5 percent jump in urban fixed-asset investment in the first two months.

Vigilance is still needed as the global financial crisis is continuing to deepen and spread, Xinhua cited Wen as saying.

China’s economic growth slowed to 6.8 percent in the fourth quarter. First-quarter data is due to be released April 16."

nearly fallen apart due to lax regulations on the financial activities of banks and brokerages

TO BE NOTED: From Daily Finance:

"China increases odds of being first big economy out of slowdown

Douglas McIntyre
Apr 11th 2009 at 3:30PM

Text SizeAAA

Filed under: Economy

China says its investment in the economy, largely from a $500 billion stimulus package, would pull its economy out of several months of lethargic growth in exports and manufacturing. It now looks like that may be true.

China has argued that its system of central government control of many of the aspects of banking and industrial output make its prospects better than those of the "corrupt" economies of the U.S. and Europe which have nearly fallen apart due to lax regulations on the financial activities of banks and brokerages. In what is probably a correct evaluation of Western economic trouble, China has insisted that the credit and mortgage-backed securities problems could not have happened in the world's most populous nation.

According to Bloomberg, "China's new lending surged more than sixfold from a year earlier to a record 1.89 trillion yuan ($277 billion) in March, adding to signs that growth in the world's third-biggest economy is gathering pace."

The news increases the odds that China will lead the world's economy out of trouble which will improve its standing among the world's large nations and give it more power in negotiations on issues like currency and world trade.

China's boasts about its ability to turn its huge economy on a dime may turn out to be true.

Douglas A. McIntyre is an editor at 24/7 Wall St."

China’s banking regulator is examining whether it needs to curb lending after new bank loans surged to a record in March

TO BE NOTED: From Bloomberg:

"China Loans, Money Supply Jump to Records on Stimulus (Update1)

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By Kevin Hamlin

April 11 (Bloomberg) -- China’s new lending surged more than sixfold from a year earlier to a record 1.89 trillion yuan ($277 billion) in March, adding to signs that growth in the world’s third-biggest economy is gathering pace.

M2, the broadest measure of money supply, grew 25.5 percent, the central bank said on its Web site today. That’s the fastest since Bloomberg began compiling data in 1998 and more than the 21.5 percent median estimate in a survey of 12 economists.

President Hu Jintao said April 1 that China’s 4 trillion yuan stimulus plan was taking effect, after urban fixed-asset investment surged 26.5 percent in the first two months. China’s lending boom contrasts with the struggle in the U.S. to rid banks of illiquid assets and efforts by central banks from Switzerland to Japan to unfreeze credit.

“China is unusual in that it has this incredible capacity to mobilize all its institutions -- central government, local governments and the entire banking system -- to boost government-influenced investments,” said Vikram Nehru, the World Bank’s Washington-based chief Asia economist.

China’s banks, which are mostly state-owned, have already met the bulk of the government’s target of at least 5 trillion yuan of new loans this year. Lending may top that level by as much as 3 trillion yuan, according to JPMorgan Chase & Co.

The explosion in credit since the central bank dropped lending restrictions in November prompted the nation’s banking regulator to warn this month that lenders face a “severe” challenge in managing their risks.

Hazard for Banks?

“The central bank had to ensure it did enough to reflate the economy,” said Kevin Lai, an economist with Daiwa Institute of Research in Hong Kong. “The question now is whether it has done more than is needed.”

A concentration of loans in infrastructure projects is a potential hazard for banks, China Banking Regulatory Commission Vice Chairman Jiang Dingzhi wrote in the April 1 edition of China Finance, a magazine affiliated with the central bank. Unusual growth in discounted bills, which are used for working capital and dilute banks’ lending profits, “deserves high attention,” Jiang said.

“The biggest dangers to China’s economy and financial system come from within, not from outside,” Jiang Zhenghua, former vice chairman of China’s parliamentary standing committee, said at a financial conference in Beijing today. “The biggest of these hidden dangers is the degree of bad loans in China.”

Not everyone agrees on the risks.

Loan Quality

China Merchants Bank Co., the nation’s fifth-largest by market value, said this week that providing money for infrastructure projects will improve the quality of its book by adding more medium- to long-term loans.

Besides the risk of bad loans, the credit boom may inflate asset prices and increase the likelihood of inflation making a comeback. The benchmark Shanghai Composite Index of stocks has climbed about 34 percent this year.

“Some of the money has gone to the property market, some to the stock market,” said Lai at Daiwa Research. “It is not what the central bank wants to see.”

Excessive loan growth may “lead to inflationary pressure in the medium term, exacerbate credit risk and could potentially contribute to higher volatility in the economy,” said Ma Jun, chief China economist at Deutsche Bank AG in Hong Kong.

Recovery Signs

Investment growth, a jump in vehicle sales and rising property transactions are among signs of a nascent recovery, according to the World Bank’s Nehru. Manufacturing expanded in March for the first time in six months, according to a government-backed index. Automobile sales rose to a record 1.08 million vehicles, the official Xinhua News Agency said.

“With loan growth rates exceeding official targets, bank regulators may urge more restraint, to guard against excessive liquidity,” Jing Ulrich, head of China equities at JPMorgan Chase & Co. in Hong Kong, wrote in a report today.

China’s banking regulator is examining whether it needs to curb lending after new bank loans surged to a record in March, the Shanghai Securities News reported on April 8, citing unidentified people.

Still, exports fell a record 25.7 percent in February, Chinese steel prices have dropped this year, and industries face “great difficulty,” according to Ou Xinqian, a vice minister of Industry and Information Technology.

Trade Surplus

China’s trade surplus shrank 45 percent to $62.5 billion in the first quarter, from $114.3 billion in the previous quarter. The country’s foreign-exchange reserves grew by the least in eight years to $1.9537 trillion, the central bank said today.

Economic growth cooled to 6.8 percent in the fourth quarter, the slowest pace in seven years. The first-quarter figure is due April 16.

Macquarie Securities Ltd. on April 8 raised its forecast for China’s growth this year by 1 percentage point to as much as 8 percent. China International Capital Corp. last week raised its estimate to as much as 8 percent from a previous forecast of 7.3 percent.

To contact the reporter on this story: Kevin Hamlin in Beijing at khamlin@bloomberg.net.

Last Updated: April 11, 2009 00:09 EDT "

Fed really had no other choice. Moreover, as we’ll discuss, this is the beginning of monetization actions by the Fed. They’re just getting warmed up.

TO BE NOTED: From Financial Sense:

"I've Got Friends In Low Places

BY BRIAN PRETTI

I have to admit that Fed actions announced at the last FOMC meeting very much took me by surprise. Point being, I did not expect the Fed to begin monetization so soon. But surprised I should not have been. Not by a long shot. To be honest, Fed monetization of Treasury debt was inevitable in the current cycle. The recent global capital flow and realized/expected Treasury issuance numbers over the last half-year really tell the whole story quite elegantly. So although there has been plenty of ranting and raving about Fed monetization, myself included, I think it’s much more important to our forward investment decision making to simply address this fact objectively and unemotionally. The Fed really had no other choice. Moreover, as we’ll discuss, this is the beginning of monetization actions by the Fed. They’re just getting warmed up. THE issue now is not the monetization itself, but rather how monetization will influence investment risk and opportunities. I'll divide up in sections the highlight points I believe tell the story of the need for the Fed to monetize and why they will not be able to stop any time soon.

THE TREASURY CALENDAR

To the point, the top clip of the chart below chronicles the issuance of US Treasuries since the beginning of 2006. Alongside is the quarterly level of like period purchases of US Treasuries by the foreign community. As I note in the chart, 3Q and 4Q of last year mark the highest nominal dollar levels of Treasury purchases by the foreign community on record. But these purchase levels were simply dwarfed by the $1 trillion+ issuance of Treasuries over the last half of 2008.

The bottom clip of the chart takes the same data and presents it as foreign purchases of UST’s as a percentage of actual Treasuries issued by quarter since 2006. The “rule” in this view of life is that the foreign community has consistently purchased well in excess of 50% of total Treasuries issued. In fact, from 3Q of 2007 through 2Q of 2008, the foreign community purchased Treasuries at a rate well in excess of 100% of total Treasuries issued. But as is absolutely clear, all of this has changed starting in the middle of last year. The bottom line today is that foreign buying of Treasuries, although at record levels in nominal dollars, has not been able to keep up with what has been and will continue to be for some time Treasury issuance on steroids. Although I will not drag you through yet another data review, you’ll have to trust me when I tell you that domestic buying of Treasuries has not and will not make up the gap. As of today, total domestic ownership of Treasuries rests at a level below that of the foreign community. The Fed is now quite simply the plug figure between projected Treasury issuance, foreign buying and levels of domestic Treasury ownership. The fact is that the Fed had no choice but to come into play right now. And so here we are. No conspiracies, no mysteries, no ranting and raving, simply the factual numbers.

Very quickly, as of right now, the OMB (Office of Management and Budget) has projected at worst an annualized $1.8 trillion deficit for the US later in the current year. From this alone we know Treasury issuance will be incredibly large. Well beyond what the foreign community would ever have the chance of soaking up. In the OMB’s view of life and under the Administration’s budget planning, expectations are for 3%+ GDP growth in 2010 and over 4% in 2011. Although we’ll have to see what happens ahead, I personally believe there is zero chance these GDP numbers will be hit. Zero. As such, the Administration’s belief/projection that the US budget deficit will fall back below $1 trillion in 2010 is wishful thinking at best and probably lunacy at worst. Point being Treasury issuance over the next few years at least should indeed be well beyond current “projections.” If anyone thinks the shortfall between projected Treasury issuance and the ability of the foreign community to soak up this issuance will somehow narrow any time soon, they are dreaming. Given the mosaic produced by putting all of these facts together, I see a picture of a US Fed who has just begun to monetize the Federal debt. Although I am absolutely guessing at this point, before the current cycle is over, Treasury monetization by the Fed may end up being five to six times what has already been announced and begun with the current $300 billion. That’s an appetizer. Don’t be surprised as this is exactly what the real numbers are pointing to dead ahead. And this of course assumes the foreign community at least keeps purchasing at levels we’ve experienced over the last year or so, which is no guarantee at all.

THE CHINA SYNDROME

We all know that at the margin China has been the key foreign buyer of US Treasuries over the current decade. From 2000 through January of this year, China accounted for 37.4% of all Treasuries purchased by foreign entities. As of now, they are the largest holder of US Treasuries on planet Earth, holding 24% of all Treasuries owned by the foreign sector. Bottom line? China’s global capital flows at the margin are extremely important. Let’s face it, it’s China who could change the dynamics of what we talked about above for the better or for a whole lot worse as we move forward. They carry the largest stick and their forward actions will be the key factor influencing just how much monetization of Treasuries the Fed will necessarily need to undertake. Again, not want to undertake, but need to undertake.

The top clip of the next chart looks at actual year-by-year purchases of US Treasuries by China. 2008 was simply off the charts. Although we do need to remember that in many senses Treasury buying in 2008 was in large part about the “safety trade” as opposed to what might be seen as mercantilist economics (essentially financing the purchasing of your exports), it’s hard to imagine China could again experience a 50% year over year increase in their US Treasury holdings in 2009. The estimated 2009 number I present in the chart is simply January’s experience annualized. Be forewarned this is a guess at best based on one-month data. From my standpoint, there is simply no way China can keep up the level of Treasury purchases we saw last year, especially when trade flows are falling like a rock and China needs to commit stimulus funds domestically.

Finally, the bottom clip of the above chart puts China’s prior purchases of Treasuries in perspective relative to total Treasury issuance over the period shown. Again, there is just no way China or the foreign community as a whole could ever dream of keeping up with current and to come Treasury issuance. The numbers are simply self-explanatory. You may have seen that just before the Geithner disguised bank bailout toxic asset plan was announced a few Monday’s back, China put out a press release reaffirming their commitment to US debt purchases. Again, the numbers belie the perceptual intent of that message as new Treasury issuance will be far too large to be sopped up by Chinese purchasing. As always, watch what they do, not what they say.

TRADING PLACES

Quick one. You know full well by now that the US trade deficit has been shrinking very rapidly over the last five months. In good part the price of oil is a factor, but equally important has been the literal collapse in global trade. When a country like China tells us its year over year exports have fallen by 25%, is there really a need for further explanation? I didn’t think so. In short, a dramatic fall off in global trade means less dollars being “exported” and exchanged for goods and services, and ultimately less global foreign reserves that may potentially be recycled back into US financial assets. The trade related monetary “juice” the foreign community, and especially China, has in its pockets both now and ahead very simply argues for a lower level of foreign buying of total US assets, not just Treasuries. And this is exactly what we are experiencing right now and should continue to experience for some time to come.

So there you have it in terms of the short explanation as to why Fed monetization was inevitable and will continue to be ahead. The foreign and domestic communities will simply not be able to soak up all of the Treasury issuance to come. And so here we now stand with the Fed as truly the buyer of last resort, in addition to being the lender of last resort. There will be no “next buyer.” Ultimately, although we’re not there yet, the ability of the US to deficit spend will rest upon the ability of the Fed to monetize sovereign debt. I just have one reminder to you as we continue to move through this very special cycle, that ability is not unlimited and not without serious longer-term consequences. Of course from an investment standpoint, it’s these potential unintended consequences that eat up most of our current investment thinking time.

Everything's All Right, I'll Just Say Goodnight And I'll Show Myself To The Door

Very briefly while we are on the subject, the issue of foreign capital flows and the ability of the foreign community to continue purchasing US Treasuries ahead is certainly a crucial monitor point in my ongoing assessment of US investment outcomes, but we also need to be aware of the rhythm of foreign investment in the broader US financial markets and specific asset classes. I’ve been through this data before so I’ll just show you one updated chart. The bottom line is that the foreign community has been heavy sellers of US agency paper, corporate paper and US equities over the last four to six months. They may not be able to keep up with Treasury issuance in their Treasury buying activity, but they are literally blowing out agency and corporate debt as well as equities in as of now almost uninterrupted fashion. The current level of foreign sales of US agency and corporate paper has never been seen before in nominal dollars. Important why? As we also heard in the Fed‘s FOMC communiqué, they are about to print and buy back another $750 billion in MBS (mortgage backed securities) paper. This is on top of the $600B in MBS purchases they announced just a short while ago. Funny thing about monetization, once it begins it can take on a life of its own in almost geometric fashion. It’s a very dangerous road to cross, but one that must be crossed at least in the land of Treasuries as I showed you above. The Fed also announced that they are considering additional purchases to include corporates and “distressed” securities. Point being, in part they fully realize that they are perhaps needing to monetize other assets being sold by the foreign community.

The chart below is a look at the longer-term foreign community purchases of all US financial assets. Interestingly, the twelve-month moving average (a measure I prefer as it smoothes out monthly “noise”) peaked in June of 2007, exactly one month prior to the July 2007 Bear Sterns twin hedge fund blowups that were in hindsight the initial rumblings of a US credit cycle about to come apart at the seams. Does action of the foreign community since that time relative to their US financial asset holdings say something about trust and faith in the US financial system from an outsiders perspective?

The Road Ahead

The Fed moving into all out monetization mode is a new construct for today’s investment community. We’re going to be navigating ahead with few historical guideposts. The poster child reference point for quantitative easing in the modern era is clearly the experience of Japan, and that’s not necessarily a comforting experiential outcome. As I'm sure you already know, Japan was very late in the game in its own post equity and real estate bubble reconciliation cycle when it decided to pull the QE monetary policy trigger. As the chart below shows us, the Bank of Japan officially announced its intention to print money to buy sovereign debt on March 19 of 2001. Within a month of the announcement, the Nikkei had rallied just over 19%. Post the rally peak, the Nikkei never saw this level again for four and one half years and proceeded to lose almost 48% of its value over the next year and three quarters post the initial QE announcement rally.

But I believe there are a number of absolutely key differential points we need to keep in mind when trying to benchmark what will be significant US quantitative easing efforts ahead, as I discussed above, against the experience of Japan. In my mind THE key differential is that Japan began their quantitative easing during a period in which the country as a whole was running a very large surplus. Conditions for the US could not be a further polar opposite at the moment. Japan began their QE efforts when household savings in Japan was quite high and had been for year’s prior. Again, quite the opposite of the current US circumstances. Bottom line? Japan began QE from a position of internal financial strength. The US now begins QE after not having been able to internally fund its own borrowing for many moons, being already heavily indebted and in a big deficit position. And so now deficit spending in the US is to move into hyper drive, supported in large part by Fed sponsored QE? A huge contrast point to the experience of Japan.

From my perspective, I see Japan’s experience as country that chose to undertake QE as a proactive monetary policy choice. And it did so from a position of surplus and savings rich financial strength. Alternatively, as I hope I made clear above, the Fed is not moving to QE as a proactive choice or within the context of greater US financial surplus and savings strength, but is rather being forced to undertake QE as quite simply there is no other buyer large enough to finance US Treasury issuance to come. In my mind, a glaring differential and potentially a key differentiation point in terms of forward economic and financial market outcomes. Without sounding melodramatic, please do not forget these key points. I believe that to blindly assume a relatively benign outcome for the US in terms of forward interest rates, global capital flows and currency valuation, as very much was the case for Japan post embarking on QE, will be a huge mistake.

Like the initial experience in Japan, US equities have so far responded favorably to the supposedly magic drug of monetization. But we need to ask ourselves in the larger picture, can US equities build an intermediate or longer term bull market case based on the rationale of massive government deficit spending supported by a Fed that will print money to fund that deficit spending? Can it really be that within the context of the global economy of the moment, the key competitive advantage of the US is a printing press? Make no mistake about it, monetization can positively influence economic and financial market outcomes for a time. We need to respect this fact. Greenspan proved this in spades during the late 1990’s pre-Y2K liquidity extravaganza in the US. As you’ll remember, the NASDAQ doubled. Of course the aftermath was none too pleasant, and continues as such to this day. As I mentioned above, I believe the key to navigating the investment environment ahead is to anticipate the unintended consequences of current government spending and Fed actions. Over the years it has been my experience that the most important drivers of asset prices are not the outcomes that can be seen and/or anticipated by the many, but rather the unseen outcomes that only the few dare anticipate. Hasn’t this exactly been the case since equity market highs of 2007? I believe it will continue to be so ahead.

Brian Pretti"

Big conversions by China or another large holder, or even market fears thereof, could trigger a massive run on the dollar.

TO BE NOTED: From the FT:

"We should listen to Beijing’s currency idea

By Fred Bergsten

Published: April 8 2009 20:12 | Last updated: April 8 2009 20:12

Zhou Xiaochuan, governor of China’s central bank, has suggested creating a “super-sovereign reserve currency” to replace the dollar over the long run. He would sharply enhance the global role of special drawing rights, the inter­national asset created by the Inter­national Monetary Fund in the late 1960s and just given an enormous boost by the decision of the Group of 20 to expand its issuance by $250bn (€189bn, £171bn). These are the first big proposals for international monetary reform from China or indeed any emerging market economy and deserve to be taken seriously for that reason alone.

Several other Asian countries, Brazil and Russia have expressed support for Mr Zhou’s ideas. The US and several other governments, however, have been quick to reject them, reaffirming their confidence in the central global role of the dollar. They apparently fear that serious discussion of this issue could shake confidence in the dollar, driving down its value and prompting a sharp rise in the euro and other currencies. Such instability and consequent rise in global interest rates would severely complicate US, European and global recovery from the crisis.

But there is a more immediate threat to financial stability from the global role of the dollar that could be significantly reduced by pursuing a more limited proposal made by Mr Zhou. The risk is that China and perhaps other monetary authorities, together holding more than $5,000bn in dollar reserves, will lose confidence in the dollar owing to the prospects for huge and sustained budget deficits in the US. Premier Wen Jiabao recently expressed such concerns in a highly unusual public statement, asking for “guarantees” of China’s dollar holdings that recall the British demand for a guarantee in 1971 that triggered the US decision to break the dollar’s link to gold.

These worried dollar holders have refrained from dumping Treasury securities only because the dollar has strengthened over the past year – which is almost certainly a temporary phenomenon – and because of the adverse global repercussions. We ignore at our peril the prospect that they may feel compelled to do so, especially if the US were to provoke the Chinese by taking aggressive trade policy actions against them. Big conversions by China or another large holder, or even market fears thereof, could trigger a massive run on the dollar.

Mr Zhou proposes to alleviate this problem by creating “an open-ended SDR-denominated fund” at the IMF into which dollar balances could be exchanged for SDRs. This is essentially the substitution account idea negotiated in the IMF in the late 1970s and for which detailed blueprints were developed. Similar anxieties about the dollar at that time prompted its sharpest plunge in the postwar period, intensifying the double-digit inflation and soaring interest rates that brought on the deepest US slowdown since the 1930s, until now.

I set out how the idea would work in an article on these pages in December 2007, in which Chinese officials displayed considerable interest. Instead of converting unwanted dollars through the market, official holders would deposit them in a separate IMF account for SDR. Their new asset would be liquid and pay a market rate of return. It would offer the desired diversification as the SDR is denominated in a basket of currencies – 44 per cent dollars, 34 per cent euro and 11 per cent each of yen and sterling.

The substitution account would be a winning proposition for all concerned. The dollar holders would obtain instant diversification. The US would avoid the risk of a free fall of the dollar. Europe would prevent a sharp rise in the euro. The global system would eliminate a potential source of great instability. These benefits call for the use of a global asset to make up any losses to the account from future falls in the dollar, such as creation of additional SDR or the IMF’s gold holdings (including the sizeable US share of them).

The main argument against such an account is that China has accumulated its dollar hoard of more than $1,000bn by keeping its currency substantially undervalued, through massive intervention in the foreign exchange markets, and thus deserves no sympathy if it takes losses on those dollars. One might even suspect that the Chinese have mentally booked such losses as the implicit cost of the subsidy to exports and jobs achieved through their currency manipulation. But there is no sign that China will stop intervening, or that its surpluses will abate, even though the US external deficit has declined sharply, and its reserve build-up is thus likely to become even more threatening.

Moreover, this is an ideal issue for China and the US to develop the informal “G2” partnership that is needed to provide global economic leadership to pass needed reforms at the existing multilateral institutions. Since China advocates currency consolidation, the US could insist that it contribute substantially to the IMF’s new lending facilities as a quid pro quo. The Europeans would have to concur, since the agreement would include a large increase in China’s voting rights at the IMF, where Europe is so heavily over-represented, but China-US agreement would go far to seal the deal.

The writer is director of the Peterson Institute for International Economics. He was assistant secretary of the Treasury for international affairs in 1977-1981 and led the substitution account negotiations for the US in 1980"

There are several factors holding back the Chinese consumer

TO BE NOTED: From the FT:

"China’s consumption is a disappearing act

Published: April 8 2009 19:46 | Last updated: April 8 2009 19:46

In January, a remarkable thing happened: more cars were bought in China, the land of bicycles, than in the US, the land of – well – cars. US annual light vehicle sales skidded below 10m, fewer than in China where January sales ran at 10.7m a year. For those counting on the Chinese consumer to ride to the world’s rescue, here, surely, was the news they had been waiting for.

Unfortunately, those vehicle numbers were not quite what they seemed. Nor – not yet, at least – is the Chinese consumer.

It turns out that China and the US count cars differently and that China’s numbers were temporarily flattered by the lunar new year. Still, China remains a bright spot in the thickening gloom. Other industries too are counting on the Middle Kingdom, the largest market for television sets and mobile phones, steel and cement. Shiseido, a Japanese cosmetics company, has been racking up 30 per cent Chinese sales growth. Alex Salmond, Scotland’s first minister, on a clean-energy-to-whisky sales tour of China this week, revealed there were more cashed-up Chinese than American students in Scottish universities.

The 19th-century Englishman who mused that, if every Chinese lengthened his shirttail by a foot, textile mills would spin year-round, has been replaced by 21st-century westerners hoping that Chinese will step in to buy their sedans and insurance products. But can they?

The picture is not easy to decipher. By some measures, Chinese consumers have in fact become relatively less important. In the 1980s, household consumption averaged slightly more than half China’s gross domestic product. That proportion fell in the 1990s to 46 per cent, reached 38 per cent by 2005 and is about 35 per cent today. By comparison, in 2007 US household consumption was running at what we now know was an unsustainable 72 per cent of GDP.

Andy Rothman, China strategist at CLSA, says people should not get hung up on that comparison. Just as in 1950s Japan, he says, a much bigger share of China’s GDP is today going to investment, something that changed in Japan only in the 1960s when consumers began to buy fridges and washing machines. Consumption rates tend to be higher in poorer countries than China where people spend a large part of their income to survive, and richer ones where discretionary spending takes hold.

Jonathan Garner, emerging markets strategist at Morgan Stanley, is another believer. In his 2005 The Rise of the Chinese Consumer, he predicted that by 2014 Chinese consumption would have risen from 9 per cent of US and 3 per cent of world consumption in 2004 to 37 per cent and 10.5 per cent respectively. By then, he forecast, the Chinese shopper would have displaced the US consumer “as the engine of world growth”. He says his prediction is still on track.

Nicholas Lardy at the Peterson Institute in Washington is more circumspect. He applauds Beijing’s attempt to rebalance a lopsided economy that is too dependent on capital investment and external demand. But so far, it has not worked. Investment probably reached a high of 43.5 per cent of GDP in 2008.

There are several factors holding back the Chinese consumer. First, people have for years witnessed the destruction of the “iron rice bowl”, as once-free health and education systems have been dismantled. Now the government is committed rhetorically – and, increasingly, in practice – to rebuilding the social safety net. But it will be years before people trust the state to look after them, and run down their precautionary savings.

Second, most Chinese are what Dragonomics, a research firm, calls “survivors”, whose purchases of basic food and clothing are meaningless for multinationals or global demand. Only about 150m are part of “consuming China”, although this may double to 300m by 2015. Consuming China’s median household income is about $6,000, against $45,000 in the US. The owner of a Beijing car does not spend like the owner of a Boston car.

Finally, China’s recent consumption boom has been predicated on rising income, itself a function of strong external demand. Growth should continue at 7-8 per cent, but the days of double-digit expansion may be over. So, rather than accelerate, Chinese household purchases may in fact slow. It turns out that Americans have been paying for everything with credit – even Chinese consumption."

Meanwhile, Governor Zhou Xiaochuan of the People’s Bank of China has produced a remarkable series of speeches and papers

TO BE NOTED: From the FT:

"What the G2 must discuss now the G20 is over

Published: April 7 2009 19:57 | Last updated: April 7 2009 19:57

Did the meeting of the Group of 20 in London last week put the world economy on the path of sustainable recovery? The answer is no. Such meetings cannot resolve fundamental disagreements over what has gone wrong and how to put it right. As a result, the world is on a path towards an unsustainable recovery, as I argued last week. An unsustainable recovery might be better than none, but it is not good enough.

EDITOR’S CHOICE

Lex: US bank bail-out - Feb-10

Video: Martin Wolf on the slow path to recovery - Feb-16

Editorial: Son of Tarp follows in father’s footsteps - Feb-10

Clive Crook: A package far from tied up - Feb-10

Video: Big bail-out bang whimpers - Feb-10

Economists’ forum - Oct-01

This summit had two achievements: one broad and one specific.

First, “to jaw-jaw is better than war-war”, as Winston Churchill remarked. Given the intensity of the anger and fear loose upon the world, discussion itself must be good.

Second, the G20 decided to treble resources available to the International Monetary Fund, to $750bn, and to support a $250bn allocation of special drawing rights (SDRs) – the IMF’s reserve asset. If implemented, these decisions should help the worst-hit emerging economies through the crisis. They also mark a return to a big debate: the workings of the international monetary system.

This is the point at which the eyes of countless readers will glaze over. It is easier for most to believe that the explanation for the crisis is solely the deregulation and misregulation of the financial systems of the US, UK and a few other countries. Yet, given the scale of the world’s macroeconomic imbalances, it is far from obvious that higher regulatory standards alone would have saved the world.

This is not just a matter of historical interest. It is also relevant to the sustainability of the recovery. Fiscal deficits are now generally far bigger in countries with structural current account deficits than in those with current account surpluses. This is because the latter can import a substantial part of the stimulus introduced by the former. The Organisation for Economic Co-operation and Development forecasts a jump in US public debt of almost 40 per cent of gross domestic product over three years (see chart). It is quite likely, therefore, that the next crisis will be triggered by what markets see as excessive fiscal debt in countries with large structural current account deficits, notably the US. If so, that could prove a critical moment for the international economic system.

Intriguingly, the country raising these big questions is China. This is, no doubt, for self-serving reasons: China is worried about the value of its foreign currency reserves, most of which are denominated in US dollars; it wants to relieve itself of blame for the crisis; it wishes to preserve as much of its development model as possible; and it is, I suspect, seeking to countervail US pressure on the exchange rate of the renminbi.

Wen Jiabao, the Chinese prime minister, has noted his country’s concern over the value of its vast reserves. At close to $2,000bn, these are almost half of 2008 GDP. Imagine what Americans would say if their government had invested about $7,000bn (the equivalent relative to US GDP) in the liabilities of not altogether friendly governments. The Chinese government is beginning to realise its mistake – too late, alas.

Meanwhile, Governor Zhou Xiaochuan of the People’s Bank of China has produced a remarkable series of speeches and papers on the global financial system, global imbalances and reform of the international monetary system. These are both a statement of the Chinese point of view and a contribution to global debate. One may not agree with all he is saying. Yet the fact that he is speaking out is itself significant.

Governor Zhou argues that the high savings rate of China and other east Asian countries is a reflection of tradition, culture, family structure, demography and the stage of economic development. Furthermore, he adds, they “cannot be adjusted simply by changing the nominal exchange rate”. In addition, he insists, “the high savings ratio and large foreign reserves in the east Asian countries are a result of defensive reactions against predatory speculation”, particularly during the Asian financial crisis of 1997-98.

None of this can be changed swiftly, insists the governor: “Although the US cannot sustain the growth pattern of high consumption and low savings, it is not the right time to raise its saving ratio at this very moment.” In other words, give us US frugality, but not yet. Meanwhile, adds the governor, the Chinese government has produced one of the largest stimulus programmes in the world.

Moreover, the vast accumulations of foreign currency reserves, up by $5,400bn between January 1999 and their peak in July 2008 (see chart), reflect the emerging economies’ demand for safety. But since the US dollar is the world’s main reserve asset, the world depends on US monetary emissions. Moreover, the US tends to run current account deficits, for this reason. The result has been a re-emergence of a weakness discussed in the twilight years of the Bretton Woods system of fixed exchange rates, which broke down in the early 1970s: over-issuance of the key currency. The long-term answer, he adds, is a “super-sovereign reserve currency”.

It is easy to object to many of these arguments. Much of the extraordinary increase in China’s aggregate savings is the result of rising corporate profits (see chart). It would surely be possible to tax and then spend a part of these huge corporate savings. The government could also borrow more: at the 3.6 per cent of GDP forecast by the IMF this year, its deficit remains decidedly modest. It is also hard to believe that a country such as China should be saving half of its GDP or running current account surpluses of close to 10 per cent of GDP.

Similarly, while the international monetary system is indeed defective, this is hardly the sole reason for the world’s vast accumulations of foreign currency reserves. Another is over-reliance on export-led growth. Nevertheless, Governor Zhou is correct that part of the long-term solution of the crisis is a system of reserve creation which allows emerging economies to run current account deficits safely. Issuance of SDRs is a way of achieving this goal, without changing the fundamental character of the global system.

China is seeking to engage the US. That is itself enormously important. However self-seeking its motivation, that is a necessary condition for serious discussion of global reforms. Yet China must also understand an essential point: the world cannot safely absorb the current account surpluses it is likely to generate under its current development path. A country as large as China cannot hope to rely on such large current account surpluses as a source of demand. Spending at home must still rise sharply and sustainably, relative to growth of potential output. It is as simple – and difficult – as that.

martin.wolf@ft.com"