An
oft-told story about drunks relates the instance
of a passer-by asking a muddled and tipsy wanderer
what he is looking for under a streetlight, only
to be told that the inebriate lost some keys in
the nearby bush but is looking under the light
because, well, there is light around.
In
much the same way, politicians and central bankers
are stumbling around aimlessly blaming any
convenient target for the problems faced by their
constituents. They need some help in connecting
the dots; here then is an attempt towards the
objective. In this article, I will examine the
common thread running
between five different
stories that surfaced this week:
Mitt Romney's pledge to save Michigan's auto
industry, that apparently won him the Republican
nomination from the state.
Mounting credit losses and attendant capital
raising by US banks.
The World Bank's most recent acknowledgment of
the corruption that plagues most of its projects,
this time involving healthcare projects in India.
China's further tightening of lending
conditions at its commercial banks even as it
announces explicit price curbs on key food and
other products.
The launch in India of the world's cheapest
car.
On the face of it, there is not much
linking these stories. The state of Michigan, for
example, plays host to America's once-mighty
automotive industry. That's not the only reason it
is in the news these days - the state also has the
dubious distinction of being in the top five most
delinquent states for personal finance (you know,
credit card debt repayment, mortgage repayment and
all that sort of thing).
Things are so bad
that some economist wags are calling the state
Michi-Gone: yes, humor is among the various
talents that economists do not possess. It is easy
to make the link between the declines of the auto
industry and the personal wealth of the state's
citizens, but that's not the full story.
Add to this the question of why the auto
companies squandered their hard-won prosperity
from the nineties (Of black swans and greedy
oilmen, Asia Times Online, January 5,
2008) and a more complex picture emerges. With a
strong US dollar that was helped along by billions
in so-called safe-haven flows following the Asian
financial crisis, America simply had too much
money, which is usually the first condition for
capital misallocation. That is what led banks and
smaller financial companies to lend willy-nilly
for mortgages, credit cards and the like
essentially to people chasing the American dream -
ie a house of your own with a two-car garage and
excessive cholesterol intake.
These
inflows kept the US dollar strong thereby making
Americans less worried about the steady rise in
oil prices and a concomitant feed through into
inflation. This house of cards could have fallen
long back but for the deflationary impact of China
adding manufacturing capacity in every conceivable
industry, which helped to keep prices low in the
US. Asians also had the good habit of saving more
than they spent, and also shipping the piggy banks
to New York for investment in anything that their
honest Wall Street advisers told them to buy (The robbery of the
century) Asia Times Online, July 14,
2007.)
Unfortunately, along the way some
Chinese decided to properly urbanize their own
cities, live in beautiful modern buildings rather
than old shanties along the Yangtze. In doing so,
the delicate price equilibrium underpinning low
inflation in the US (and Europe) swung out of
control and unleashed greater inflation, in turn
pushing central banks to raise rates. Rising
interest rates in turn made bankrupt the people
borrowing money they couldn't pay for houses they
couldn't afford on incomes they didn't have.
It just so happened that a number of such
people had been recently made redundant by the
auto factories in Michigan, and thus had more than
ample time to become property "investors".
The banks that lent them a lot of money
have now had to fess up to their losses. Worse,
they have opened their doors to a bunch of new
owners from the Middle and Far East, who may not
be the sharpest knives in the cupboard (Storm warning for Asia
Asia Times Online, January 4, 2008) but will at
the very least prevent these banks from opening up
their balance sheets to risky US homeowners in
future - remember after all that these are the
same chaps who cling on to the lessons of the
Asian financial crisis of 1997 as if that were the
only event in their sorry little lives.
I
am not sure that Mitt Romney or indeed any other
politician understands the dynamics laid out
above: thus when they talk about defending America
by making the US dollar cheaper for example, they
would also sow the seeds for a permanent wealth
cut of these homeowners. Meanwhile, the ones
dreaming of restoring the US dollar to its glory
would have to pass the shovel around to bury the
remnants of the American auto industry. As much as
it hurts Mitt and Co, the US dollar has lost
credibility because of the economy, not the other
way around. They should pay some attention to the
experience of India's Nano car, which is profiled
below, as it shows the right response of a
capital-starved company to a changing market
dynamic.
Meanwhile, in
Wonderland A recent report by the World
Bank uncovered significant corruption in its aid
to India across multiple projects totaling some
US$550 million [1]. The bank's new chief, Robert
Zoellick, and Indian officials promised to get to
the bottom of the mess, quite ignoring that the
very high likelihood that the key culprit was the
aid program itself.
There is an old saying
that give a man a fish and he will eat once; teach
him how to fish and he will lie forever about the
size of the one he caught with Todd the other day.
That aside, the point that making a large pot of
money available to people in poor countries
without the relevant safeguards has been lost on
the "ugly sisters" - the International Monetary F
and the World Bank - for many decades now. Their
own bankers remain distant, academic and
uninvolved, thereby allowing easy assignment of
blame to ex-colleagues. Asian countries remain
notoriously corrupt (Wages of corruption, Asia
Times Online, August 19, 2006) and yet the World
Bank insists on throwing money at non-existent
projects. Bankers caught with their hands in the
cookie jar are reprimanded, but almost never
dismissed thanks to the complete lack of
accountability at the World Bank as well as the
frequent US-European management skirmishes.
Meanwhile, the central bank of China finds
itself in the sorry situation of being both the
poacher and the gamekeeper as it attempts to fend
off dodgy loans by commercial banks even as it
floods the financial system with liquidity that
has in turn led to surging prices for pork and
other foods (Inflation: China's Lost
Battle Asia Times Online, December 15,
2007). Attempting to control lending to
"inflationary" sectors like construction, the
government has mandated banks to lend to
"desirable" sectors such as development projects
in the hinterland. This has led to some
interesting loan decisions across the country to
dubious industrialists and businessmen on
non-existent collateral. Frequently, the heads of
major Chinese banks disappear only to be placed on
a corruption trial and then shot in the back of
their heads [2]. Reading about the different
outcomes for bankers at the World Bank and China's
commercial banks does make me wonder if the
punishments aren't interchangeable, but perhaps
that's just me.
The problem is that in
both China and at the World Bank, lending
decisions are mandated from the top rather than
being made commercially. This leads money to be
allocated to undeserving projects, even as more
deserving (economic) candidates are ignored
because they are out of policy. Other instances of
such policy madness certainly exist - for example,
a forum member (Chan Akya forum, Asia Times
Online) asked a question about "priority" lending
to India's Muslims by commercial banks. This is a
bad idea that is intended to stave off a serious
problem, namely the relative economic backwardness
of India's urban poor including Muslims (India's Muslim 'problem')
Asia Times Online, September 1, 2007.) As Chinese
banks are learning now, being forced to lend based
on economic policy is about the worst kind of
investment decision that can be made.
Both
the World Bank and the People's Bank of China
(PBoC - central bank) though should take a look at
the cheapest car in the world, called the Nano,
launched in India this week. The car represents a
shift in the thinking of domestic manufacturers in
Asia, as it is targeted firmly at an audience
within the country at a price that more lugubrious
foreign competitors will find difficult to match.
This is a confident step from one the region's
biggest conglomerates aimed at the very heart of
today's mega-corporations in the US and Europe.
The car also represents a paradigm shift
for another reason. The export boom in China's
industries from the eighties relied heavily on a
resource advantage, namely cheap labor. India's
information technology boom also relied on the
relative cheapness of its engineers, although the
gap narrowed far quicker than China's labor wages
gap has (to equivalent workers in the US). As a
labor advantage disappears, China and India have
gone on a brand expansion spree as they attempt to
capture more value-added products and brands.
That's a fancy way of saying that since our
workers are more expensive, our products will have
to cost more.
What the Nano represents
though is sheer unbridled innovation; original
thinking and engineering savvy that would make
richer countries sit up and take notice. It is no
longer the brute force of cheap resources, but the
more tangible strides of engineering prowess that
would give global automakers sleepless nights.
As one news service (Bloomberg) called it
this week - "Nano is talk of the Detroit motor
show, and its not even there". True, there has
been more than the usual criticism about the car's
design, features and all that, but the underlying
nervousness is palpable: "If these guys can
deliver more than a passable car at US$2,500, what
can they do for a budget double that? None of us
can deliver a car for under US$15,000, so we have
some way to go."
Every one of those
reasons should convince the World Bank and the
PBoC, among other policymakers, that the most
useful contribution they can make to their and the
world economy is to simply get out of the way. For
the World Bank, this would mean turning itself
into an academic institution that trains future
economists, while for the PBoC it would mean
letting the yuan float and get out of the business
of managing bank balance sheets.
This will
push the yuan higher against the US dollar and
over the short-term cause billions of dollars in
lost profits (not losses) for manufacturers,
before they too get the joke like Indian
manufacturers have about improved resource
optimization and value addition on a tight budget.
Chinese banks will lend to the most
credible businessmen, and they will in turn
unleash superb innovations that change the global
industrial landscape; evolving from their position
as mere assemblers of Western and Japanese
technology.
US banks have shown that being
in a free market doesn't make them immune to
market abuse as well as reaping the fruits of such
actions. Their ability to attract capital will
hopefully be accompanied by a new humility with
respect to financial innovation, but also an
acknowledgement of new economic realities that put
developing Asia in front of all other
constituents. Group of Eight economies are a drag
on the world now (Dear Dinosaurs Asia Times
Online, October 20, 2007); the only choice for
these banks is to focus all their energies on
Asia.
Thus, what unites all the stories is
the fallacy of top-down decision-making that
ignores ground realities and more importantly the
integral impact of decisions on each other. The
unwinding of one bubble will almost always set off
another, targeting areas of uneconomic
decision-making. If the authorities in China and
India do not wake up to this reality, the current
asset bubble in stocks and property will also blow
up in much the same way as the American dream has.
Notes 1. Detailed Implementation
Review of the Department of Institutional
Integrity, World Bank, 2008. 2. From later this
year they will no longer be shot, but have more
humane lethal injections instead.
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