Page 1 of 2 Paulson placates China, Russia - for now
By Julian Delasantellis
At the fairly tough American secondary school I attended, the most feared guy
at the place was not the big burly 130 kilo American football linebacker, nor
was it the young ghetto tough being given one last chance by the judge to
straighten himself out before being sent to adult prison. It was a kid that,
for the sake of this article, I'll call Lester.
Granted, the football player and the hood could rearrange your skeleton fairly
efficiently, but Lester was considered even more dangerous. He possessed the
unique skill of, whenever he desired, being able to summon up and eject, with
perfect vectored precision, the most fearsome quantities of vomit imaginable.
Therefore, he could put French fries and ketchup down the blouse
of the captain of the cheerleading team, or call members of minority groups at
the school appellations that today would get someone weeks upon weeks of
diversity training, and never face any sanction, not from the cheerleader's
wrestler boyfriend, nor from the other members of the minority group that hated
being at our school as much as our parents and teachers hated having them
there.
Not even the school principal, a big tough former US Marine who always seemed
to traverse the halls as if he was once more landing on the beaches of the
South Pacific, wanted anything to do with Lester; he brought him in for a talk
one day, and the reek lingered in his small, overheated office for months.
It looks like, in dealing with the economic and geopolitical challenges of the
21st century, the United States is well following in Lester's rank shoes.
The big news of Monday was
the world equity markets' ecstatic reaction to the
US government's penultimate rescue of the Fannie
Mae and Freddie Mac mortgage guarantor
government-sponsored enterprises (GSEs) - with the
notable exception of China (see China investors also want
help
). Stocks rallied 3.38% in Tokyo,
4.32% on the Hang Seng in Hong Kong, just under 4% in London, and the world's
money day ended with an over 2.5% rally for the Dow Jones Industrial Average
in New York.
Averaging out the world's major stock markets comes out with about a 2% gain
for the day, with an estimated US$50 trillion in world stock market
capitalization, Treasury Secretary Henry Paulson and Co just created about a
trillion dollars in wealth today. That's a very good day indeed, especially
considering that the eight years of the Bush Administration are ending with US
stock prices essentially unchanged (except for the NASDAQ, where they are much
lower) from where they started.
With the intervention proving so good for stock investors (with the noted
exception of those with Fannie and Freddie's stock, who are seeing their
investments essentially wiped out with these events), wags must wonder, with
the current American dominant cultural philosophy being that nothing succeeds
like excess, if taking out just two companies is worth one trillion, what about
some more?
Perhaps that is just reductio ad absurdum - then again, that's precisely
the direction, re-regulation, a pushback from the last third of a century's
near fanatic obsession with markets always being right and governments always
being wrong, in which the current world finance crisis has been pulling
macroeconomics, the practice of government management of the economy, since the
crisis began over a year ago.
With the exception of Republican Party vice presidential candidate Sarah Palin,
who before the rescue plan was announced opined that the GSEs had gotten both
too big and too expensive for the US taxpayer (wrong on both counts - although
this may well change with the upcoming rescue plan, as the two have not cost US
taxpayers a dime, and have provided incalculable benefits), most informed
observers (well, there's the Palin problem) believe that the rescue plan was
inevitable and absolutely necessary.
In this, the consensus is, perhaps for the first and only time, absolutely
right.
As I stated on Asia Times Online on July 16 (see
Jaws close in on Bernanke), the attempt by the markets to create a
non-governmental alternative, called credit default swaps, to the
mortgage-guarantor function of the GSEs, with their implied backing by the
government now made explicit, collapsed in the same spectacular failure as the
market for subprime mortgages.
These days, if an American mortgage or a home refinancing is not eligible for
purchase by the GSEs it's not getting made; if Fannie and Freddie suddenly
disappeared this one last support under what's left of the US real estate
market would be gone. In a nation where people are currently putting their
groceries on plastic, to be paid off with minimum monthly payments on their
charge cards for ages to come, you can just imagine how many new real estate
deals would be getting done if prospective homeowners had to bring $400,000 to
the closing table in $10s and $20s.
But amidst all the American media once again not knowing the difference between
an economics story and a personal finance story, as in its theme of "what the
rescue means to your wallet?" that dominated the coverage, the aspect not at
all examined is the international ramifications of these events. For a nation
that has basically accepted the contention that Alaska Governor Palin is a
foreign policy expert on the level of Henry Kissinger or Metternich just on the
basis of Alaska's proximity to Siberia, it might be a surprise to be told that,
" yes, America, there is a world out there."
Last Thursday, September 4, the New York Times published probably the closest
thing to journalism's apocryphal "man bites dog" story, in that it reported,
referring to the People's Bank of China, the country's central bank, that the
"Main Bank of China Is in Need of Capital". For a world accustomed to stories
about the quantity of China's foreign exchange reserves spinning always ever
upward like slot machine jackpots, this was a surprise; had the human race, or,
more specifically that large subsection of it that shops at Wal-Mart, finally
weaned itself from it's addiction to cheap microwaves and plasma TVs?
By now, the problems attendant to China's recent economic success are fairly
well known. China is running a roughly $25 billion a month trade surplus with
the US. Standard floating exchange rate theory states that countries
experiencing large trade surpluses see their currencies appreciate, with the
flip side of that being the deficit countries' currencies depreciating.
Eventually, the deficit country finds that the rising prices caused by its
currency's depreciation means it can't import as much as it used to, and the
surplus country finds it can buy more, now cheaper, imports. Over time, if the
system works the way the free market theorists say it should, the combination
of increased imports to the surplus country and increased exports from out of
the deficit country should whittle away the deficit to a manageable level -
well, someday it might.
But China has not wanted to play this game. Fewer exports from out of Chinese
factories means fewer paychecks earned by Chinese factory workers, and, for all
the gleam and beauty on display at the Olympic Bird's Nest stadium, China's
Communist rulers apparently still fear that there's just not enough distance
between the two to keep an unemployed factory worker of the Pearl River Delta
from showing up as a protester in Tiananmen Square. They don't want their
currency, the yuan, to rise too fast against the US dollar.
A rising yuan is the same thing as a falling dollar, and the dollar, just like
anything else, will fall if there are more sellers of it than buyers, if supply
exceeds demand. Therefore, the People's Bank of China has been acting to buy
lots of those loose dollars on the markets, attempting to keep the yuan's rise
at least orderly.
And what are they doing with all the dollars accrued with their currency market
interventions? Well, mostly, they're buying US government-guaranteed notes and
bonds; that includes, according to Marketwatch, $376 billion of Fannie and
Freddie Mortgage Backed Securities (MBSs). Before this past weekend, these were
assumed to be de facto guaranteed by the US government; after the bailout by
Paulson, that backing is now explicit
Mortgage-backed securities pay higher rates of interest than comparable
maturity US Treasuries, but with every higher return comes a higher risk, and
the risk here is that the mortgages that the securities are based on don't get
paid back - at which time the securities become worthless. With about 300,000
US homeowners now defaulting on their mortgages every month, that's precisely
what's now eroding the value of the MBSs in the People's Bank of China's
portfolios.
According to Guanghua School of Management Professor Michael Pettis, the black
hole of MBS in the Bank of China's vaults has led to a neat little contretemps
between the bank and its paymasters in the Chinese Ministry of Finance (MoF).
Like governments and bureaucracies everywhere, the MoF has discovered the
convenience of holding two, diametrically opposite positions on the same issue.
It wants the PBoC to stop losing money with the offal American MBSs in their
portfolio, losses which have made it "in need of capital," according to the NY
Times; but the MoF also wants the central bank to stop supporting the
snail-like rise in the yuan that has seen it rise about 18% against the dollar
over these past three years.
As the trade surplus with America is shrinking ever so slowly, it is only the
PBoC's dollar-buying program that has kept the yuan from rising much higher
much faster. If the MoF wants to stop the yuan's rise dead in its tracks, it
will have to commit to much larger purchases of US dollars. The receipts from
these interventions have to go somewhere, and if not into MBSs, where? US
Treasuries are not as directly exposed to the housing market's fortunes as are
MBSs, but they pay much less. All in all, getting China hooked on high-interest
MBSs has become something of a lose-lose proposition for China.
With this as a backdrop, it's not surprising, according to an article from the
Saturday Wall Street Journal, before the rescue plan was announced, that "In
recent weeks, Treasury officials have been reaching out to foreign central
banks and other overseas buyers of securities or debt sold by the two
companies, to reassure them of the creditworthiness of these instruments."
Seen in this light, the entire rescue plan was nothing but a move
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