Asia Time Online - Daily News
Asia Times Chinese
AT Chinese

     Sep 10, 2008
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 

Continued 1 2 

Bear-faced bluff
(Aug 30,'08)

Leviathan's return
(Aug 28,'08)

1. How Obama lost the election

2. Hindu gods spike Chinese dragon

3. Azerbaijan at crosswinds of a new cold war

4. US shrinks from arming Georgia

5. China still on-side with Russia

6. Militancy dogs Pakistan's new president

7. China's Paralympic possibilities

8. What Sondhi really wants for Thailand

9. The assets of penultimate fools

10. McCain stars in 'Back to the Future 08'

11. Triangulating an Asian conflict

(24 hours to 11:59pm ET, Sep 8, 2008)



All material on this website is copyright and may not be republished in any form without written permission.
Copyright 1999 - 2008 Asia Times Online (Holdings), Ltd.
Head Office: Unit B, 16/F, Li Dong Building, No. 9 Li Yuen Street East, Central, Hong Kong
Thailand Bureau: 11/13 Petchkasem Road, Hua Hin, Prachuab Kirikhan, Thailand 77110