Last week the United States stock markets dropped dramatically…the Dow Jones Index fell significantly below 10,000. This week the same markets are up sharply…the Dow Jones closed yesterday at almost 10,140.
Most financial markets this year have been especially volatile. All measures of volatility have risen. Yet, the world goes on!
When the markets are down, gloom pervades the scene and fears of a double dip recession or a drop back into economic depression flood media outlets. When the markets are up, optimism about the economic recovery increases.
Yet, this volatility is the better alternative to a financial market collapse which has been avoided this year, up to this point.
Where does this leave us?
What I have tried to convey in my recent posts is that economic conditions, in general, are improving but that there are a lot of problems that have not been fully resolved at this point. In essence, things are getting better but we are not “out-of-the-woods” yet.
On what do I base this conclusion?
At this point in time I see a lot of people trying to work out the problems that exist. Where the problems are identified and “owned” the process of resolution goes forward. When people fail to accept the fact that problems exist and deny that anything needs to be done to correct them, the road gets bumpy and further market problems ensue.
A case in point is the European crisis that took place earlier this year. Denying that a problem existed in the financial position of several European governments only exacerbated the situation and led to substantial financial turmoil. A cloud still hangs over the European Union with respect to the bank stress tests that are now going on. It took a major effort to make these tests a reality, but now the whole process is cloaked in a secrecy that only creates more fear and concern. When will people learn that opaqueness does not breed confidence?
As I have written before, “quiet” is good. That is, financial markets do not like surprises or the fear of surprises. Problems may exist, but if it appears as if people recognize that problems exist, if people are working hard to identify the problems, and if people are applying resources to correct the problems, the world goes along.
In such an environment there will be bad news from time-to-time, just as there will be good news. The financial markets, however, do not like news that falls outside the bounds of what is expected. In this respect, market participants are on the alert for “surprises”, especially “bad” surprises, pieces of information that indicate that things are worse than they had expected.
At times like the present, financial markets are particularly sensitive to bits of news that might point to “bad” outcomes.
The problem with “bad” outcomes is that they may cause people to discard their previous expectations. The danger is that the destruction of expectations may be so severe that people stop trading until they are able to re-construct expectations that they are willing to trade on. A time period in which people stop trading is a “liquidity crisis” and is usually connected with the breakdown of market expectations due to a “surprise” that shakes the market.
Many believe that European leaders risked such a consequence in their response to the financial market disruptions that took place earlier this year.
So what we want is a period of relatively “quiet” economic activity so that the problems that exist within the economy can be worked out. There is no arguing against the fact that there are still a lot of problems areas in the world today. That is why there is so much volatility in the financial markets. With so many problems still in existence, there are still many, many possibilities that new “surprises” may be discovered. Market participants have a right to be jittery.
In my mind, additional governmental stimulus programs will not correct this situation. More spending stimulus from the government, if it has any effect, will only work to postpone the resolution of currently existing problems. These problems must be worked out or they will just carry over to the next period of financial distress.
In fact, I have argued that this is what has happened over the past fifty years or so as governments have tried to stimulate economic activity in order to avoid excessive amounts of unemployed labor. The result of this activity, however, has been excessive amounts of under-employed labor as well as unemployed labor. (See my post, “Jobs and Skills: The Current Mismatch,” http://seekingalpha.com/article/213163-jobs-and-skills-the-current-mismatch.)
Government efforts to achieve “quiet” results are apparent in the banking industry. Big banks do not seem to be the major problem: problems do seem to exist among the “less-than-big” banks. Both the Federal Reserve System and the Federal Deposit Insurance System are working to provide an environment in which these problems may be worked out in an orderly fashion.
First, the Federal Reserve has provided for a massive infusion of liquidity into the banking system by keeping its target interest rate near zero and allowing for about $1.0 trillion to remain on bank balance sheets as excess reserves. In additions, the FDIC has instituted a systematic process to close problem banks and to encourage a change in control of many other banks short of capital.
The result has been a steady handling of the problems in the banking system with no surprises. At least, no surprises up to this point in time. This is good…very good!
And, what do we see happening? People are seeing opportunities popping up in these “smaller” banks. (See my post from yesterday http://seekingalpha.com/article/213630-are-smaller-banks-a-good-investment, but also today from the Wall Street Journal, “Wilbur Ross’s N. J. Bank Play,” http://online.wsj.com/article/SB20001424052748703609004575355031598784308.html?mod=ITP_moneyandinvesting_2.)
Problems are also being worked out in the economy as a whole. However, this “work out” process takes time and since it took about 50 years for the United States to get into the position it now finds itself in, things are not going to right themselves overnight. Impatience, like further short run fiscal stimulus plans, will not correct the situation because they work “against” the healthy correction of the economy, they do not work “with” the natural flow of activity. There are ways the government can work “with” the correction, but these also require patience for they have to do with re-training, education, innovation and a changing structure of incentives.
Volatility comes with the territory we now occupy. Volatility comes with the release of bad news and good news on the economy, government finances, and company performances. The volatility comes because people are still trying to understand what is going on and whether or not expectations are going to be met. However, knowing that people accept the problems and are working to correct them creates an environment that is more conducive to trust than the failure to acknowledge the fact that problems might exist. Even in hard times, knowledge is better than ignorance…or foolishness.
Friday, July 9, 2010
Thursday, July 8, 2010
Are Smaller Banks a Good Investment?
The general picture I have been drawing of the banking industry is as follows: big banks are doing well; banks that are not big are not doing so well.
Who do I consider to be the big banks?
The big banks are the largest twenty-five domestically chartered banks in the United States and these banks hold two-thirds of the banking assets in the country. These banks, as a group, are doing very well.
The not-big banks are all the rest, some 8,000 domestically chartered banks that hold approximately one-third of the banking assets in the United States. These banks are not doing so well.
The evidence of the condition of these not-big banks is that the Federal Reserve is keeping its target rate of interest at 25 basis points or below and has pumped around $1.0 trillion in excess reserves into the banking system. The FDIC has approximately one out of every eight banks in the country on its problem bank list and is closing three to four banks, on average, every week. It is expected to continue at this pace for another 12 months or so.
Commercial banks are not making loans and this is true of the not-big banks as well as the big banks. In the not-big banks the problem seems to be dealing with the bad assets they have on their balance sheets rather than just an absence of potential borrowers.
Yet, within this environment, we hear and read about people, funds, or groups buying up the smaller banks and attempting to consolidate them into viable and vibrant regional banks…and possibly more. The New York Times on July 8ran an article on just this type of activity: “Financier Invests in a New Jersey Bank”, http://www.nytimes.com/2010/07/08/business/08bank.html?_r=1&ref=todayspaper.
Does this make sense?
My answer to this is “Yes, it does make a lot of sense!”
The New York Times article is about Wilbur L. Ross, Jr. who is expected to announce the purchase of a stake in the New Jersey banking company Sun Bancorp, an organization that has around $3.5 billion in assets.
Mr. Ross, according to the article, has predicted that “hundreds of the nation’s troubled banks will fail” and that there will be a substantial consolidation of the banking industry over the next few years. In earlier posts, I have also argued that the banking system, now at 8,000 banks, will consolidate, dropping to a total of no more than 5,000 banks in the next five years, maybe even a lot fewer.
Ross, who has already acquired banks in Florida and Michigan, stated that this acquisition could be the first of many he acquires in New Jersey.
“The next 18 banks in size (in New Jersey) after this one (Sun), together, have around $5 billion in deposits, and there’s another 100-some-odd banks that, in total have $40 billion in deposits.” Ross argues that “That’s just way too many banks for one state to have.”
The financial industry is changing. The largest twenty-five commercial banks in the country are going to be one thing. I believe that these banks will move from about two-thirds of the banking assets in the country to about three-fourths. They will be an entirely different animal of their own making. I have written many posts on what these banks might become in the Information Age.
The other one-fourth of the banking assets in the country will be in banks that are larger than the average not-big banks that now exist, but will be more “client-first” banks, banks that are more relationship based like the outstanding banks we knew in the past.
Certainly, these banks will change because they, too, are a part of the Information Age. However, they will not be the diversified financial giants inhabiting the territory of the largest twenty five big banks. But, this change to incorporate the technology of the Information Age will alter these smaller banks in a fundament, yet different way. More on these changes in future posts.
Aside: It is interesting that a new biography is just currently hitting the book stores, one that deals with an “old fashioned” banker who emphasized, successfully, doing business in the traditional way. See “High Financier” The Lives and Time of Siegmund Warburg” by Niall Ferguson. Yes, this is the Niall Ferguson that wrote “The Ascent of Money.”
I believe that there exists a tremendous opportunity in the restructuring that is currently taking place in the banking industry. Of course, one must not rush into these “deals” hastily for there are many problems that still exist within the industry. Remember, that is a major reason that the Federal Reserve is keeping interest rates so low. Also, there is the change in financial regulations that are currently being written in Washington, D. C.
Still, there is a major restructuring taking place in the banking industry and when such a restructuring takes place in an industry, opportunities abound. This is a chance to get in on the ground level with the “new” relations-based commercial banking platform. It is a chance to be a part of the new “Information Age” banking organization. And, to me, this restructuring is going to take place through the consolidation of existing banks so as to achieve the appropriate scale and geographic distribution of offices.
The consolidation of banks will not be achieved over night because of the time and energy it takes to put organizations together. Furthermore, many of the consolidating banks will have problems, these banking assets must be “turned around” as well as combined and this will take time and energy. But, it can be done.
Furthermore, these banks need to be “conservatively” run. That is, in my mind, the new banking rules and regulations will not be an impediment to success. I have been a part of three “turnarounds” myself, two as a CEO and one as a CFO, and have raised millions in capital. I always wanted these banks to have policies and procedures that were stricter than those imposed by the bank regulators because I did not want regulators to have a say in the decisions of the bank. Even within this “conservative” requirement, the banks were “turned around” and achieved attractive returns. This can also be achieved within the current environment.
Smaller banks can be a good investment and an organization intent upon building a 21st century, client-based commercial bank through the consolidation of these smaller banks, I believe, can be quite successful. This is certainly an area to keep an eye on.
Disclosure: I am now a board member of a startup organization, e3bank, attempting to build a 21st century, client-based bank. More information can be found on this bank at http://www.e3bank.com/.
Who do I consider to be the big banks?
The big banks are the largest twenty-five domestically chartered banks in the United States and these banks hold two-thirds of the banking assets in the country. These banks, as a group, are doing very well.
The not-big banks are all the rest, some 8,000 domestically chartered banks that hold approximately one-third of the banking assets in the United States. These banks are not doing so well.
The evidence of the condition of these not-big banks is that the Federal Reserve is keeping its target rate of interest at 25 basis points or below and has pumped around $1.0 trillion in excess reserves into the banking system. The FDIC has approximately one out of every eight banks in the country on its problem bank list and is closing three to four banks, on average, every week. It is expected to continue at this pace for another 12 months or so.
Commercial banks are not making loans and this is true of the not-big banks as well as the big banks. In the not-big banks the problem seems to be dealing with the bad assets they have on their balance sheets rather than just an absence of potential borrowers.
Yet, within this environment, we hear and read about people, funds, or groups buying up the smaller banks and attempting to consolidate them into viable and vibrant regional banks…and possibly more. The New York Times on July 8ran an article on just this type of activity: “Financier Invests in a New Jersey Bank”, http://www.nytimes.com/2010/07/08/business/08bank.html?_r=1&ref=todayspaper.
Does this make sense?
My answer to this is “Yes, it does make a lot of sense!”
The New York Times article is about Wilbur L. Ross, Jr. who is expected to announce the purchase of a stake in the New Jersey banking company Sun Bancorp, an organization that has around $3.5 billion in assets.
Mr. Ross, according to the article, has predicted that “hundreds of the nation’s troubled banks will fail” and that there will be a substantial consolidation of the banking industry over the next few years. In earlier posts, I have also argued that the banking system, now at 8,000 banks, will consolidate, dropping to a total of no more than 5,000 banks in the next five years, maybe even a lot fewer.
Ross, who has already acquired banks in Florida and Michigan, stated that this acquisition could be the first of many he acquires in New Jersey.
“The next 18 banks in size (in New Jersey) after this one (Sun), together, have around $5 billion in deposits, and there’s another 100-some-odd banks that, in total have $40 billion in deposits.” Ross argues that “That’s just way too many banks for one state to have.”
The financial industry is changing. The largest twenty-five commercial banks in the country are going to be one thing. I believe that these banks will move from about two-thirds of the banking assets in the country to about three-fourths. They will be an entirely different animal of their own making. I have written many posts on what these banks might become in the Information Age.
The other one-fourth of the banking assets in the country will be in banks that are larger than the average not-big banks that now exist, but will be more “client-first” banks, banks that are more relationship based like the outstanding banks we knew in the past.
Certainly, these banks will change because they, too, are a part of the Information Age. However, they will not be the diversified financial giants inhabiting the territory of the largest twenty five big banks. But, this change to incorporate the technology of the Information Age will alter these smaller banks in a fundament, yet different way. More on these changes in future posts.
Aside: It is interesting that a new biography is just currently hitting the book stores, one that deals with an “old fashioned” banker who emphasized, successfully, doing business in the traditional way. See “High Financier” The Lives and Time of Siegmund Warburg” by Niall Ferguson. Yes, this is the Niall Ferguson that wrote “The Ascent of Money.”
I believe that there exists a tremendous opportunity in the restructuring that is currently taking place in the banking industry. Of course, one must not rush into these “deals” hastily for there are many problems that still exist within the industry. Remember, that is a major reason that the Federal Reserve is keeping interest rates so low. Also, there is the change in financial regulations that are currently being written in Washington, D. C.
Still, there is a major restructuring taking place in the banking industry and when such a restructuring takes place in an industry, opportunities abound. This is a chance to get in on the ground level with the “new” relations-based commercial banking platform. It is a chance to be a part of the new “Information Age” banking organization. And, to me, this restructuring is going to take place through the consolidation of existing banks so as to achieve the appropriate scale and geographic distribution of offices.
The consolidation of banks will not be achieved over night because of the time and energy it takes to put organizations together. Furthermore, many of the consolidating banks will have problems, these banking assets must be “turned around” as well as combined and this will take time and energy. But, it can be done.
Furthermore, these banks need to be “conservatively” run. That is, in my mind, the new banking rules and regulations will not be an impediment to success. I have been a part of three “turnarounds” myself, two as a CEO and one as a CFO, and have raised millions in capital. I always wanted these banks to have policies and procedures that were stricter than those imposed by the bank regulators because I did not want regulators to have a say in the decisions of the bank. Even within this “conservative” requirement, the banks were “turned around” and achieved attractive returns. This can also be achieved within the current environment.
Smaller banks can be a good investment and an organization intent upon building a 21st century, client-based commercial bank through the consolidation of these smaller banks, I believe, can be quite successful. This is certainly an area to keep an eye on.
Disclosure: I am now a board member of a startup organization, e3bank, attempting to build a 21st century, client-based bank. More information can be found on this bank at http://www.e3bank.com/.
Tuesday, July 6, 2010
Ho-hum, the Financial Reform Bill is Going to be Passed
Perhaps the most benign statement about the passage of the United States financial reform bill passed by the House of Representatives last week and whose passage is pending in the Senate comes from Richard Bove, banking analyst at Rochdale Securities: The bill, he states, “doesn’t seem to be terribly onerous.” (See “JPMorgan Brushes Aside Bill Concerns,” http://www.ft.com/cms/s/0/24bcbc8c-8858-11df-aade-00144feabdc0.html.)
In terms of the regulation of swaps, especially credit default swaps, “The once-feared swap provision has become toothless.”
The recent debate in Congress over the financial reform bill: A lot of “sound and fury signifying nothing.”
This legislation, the most comprehensive reform of the financial system since the 1930s, seems be passing into the history books with very little fanfare.
Sure, the financial institutions “huffed and puffed” and spent tons of money to fight Congress “every inch of the way.” But, what else did you expect. Perhaps you need to read a good economics book on “Game Theory”.
And, now?
Can’t you hear the executives at the big banks say, under their breath, “Well, the bill is passed, now we need to get back to business. Sure we spent a lot of money that could have gone elsewhere, but that is now history. In terms of where we are going to focus in the future, we just continue doing what we have been doing, finding the best way to do business and to make money. The bill, itself, will cause some inconvenience in some areas, hurt the smaller institutions more than the larger ones, but will not basically change what we are going to be doing.”
The article cited above states it all. JPMorgan acquired a large energy and metals trader last week. How will the financial reform bill impact this deal? After all, “Commodities are among a handful of derivatives still targeted…” by the bill.
The author of the article writes: “Blythe Masters, head of commodities at JPMorgan, said the bank already traded most energy through an affiliate and the law would ‘not substantially’ affect business.”
I have been arguing for months that the large banks had already moved beyond the reach of the regulations being discussed in Congress and that anything enacted by the legislators would be DOA, “dead on arrival.” The large banks started to reform and restructure themselves soon after the fall of 2008 when the financial crisis was at its peak! By the spring of 2009 these banks were well on the way to the future.
Congress, on the other hand, was mired in the past.
JPMorgan, to my mind, is one of the organizations leading us into the future. See, for example, my blog post “Follow the Dimon,” (http://seekingalpha.com/article/212236-follow-the-dimon). But, there are many others that are also out there pushing finance into the future.
Similar discussion are taking place in all areas of the finance field. Just this morning, the Wall Street Journal contained the article “What’s a ‘Prop’ Trader Now?” relating to the proprietary trading that many of the largest financial institutions engage in. (See, http://online.wsj.com/article/SB10001424052748703620604575349161970563670.html?mod=ITP_moneyandinvesting_0&mg=com-wsj.) The article addresses issues like, “What are ‘Prop’ traders?” and “How are banks redefining ‘Prop’ traders?” and “Where are ‘Prop’ traders located within the organization?”
The answers to these questions will help the larger financial institutions “churn out” billions of dollars in profits. Thus, the banks are willing to spend millions of dollars in hiring “the best and the brightest” lawyers and financial experts to come up with the answers. Congress is just not capable of matching the resources available to these publically-traded firms and so will lag behind what is going on in the private sector. To me, the information “gap” between the public sector and the private sector has never been larger.
The problem is that Congress is attempting to achieve “outcomes”. They want to keep banks from becoming “too big to fail” and to keep banks from taking on too much risk. Historically, we see that laws and regulations that seek “outcomes” are bound to fail because, specifying “outcomes” tells those being regulated what they have to “get around”, what they have to “evade.”
In this Age of Information, it has become exceedingly easy to “get around” laws and regulations and “evade” the restrictions imposed by the legislators and regulators. (See the series of posts I began on January 25, 2010, “Financial Regulation in the Information Age”: http://seekingalpha.com/article/184153-financial-regulation-in-the-information-age-part-a.)
Laws and regulations work better when they are aimed at processes, the way that the regulated firms do business. These kinds of rules and regulations have to do with information flow (corporate disclosure and transparency), how trades are made, how trades are constructed, margin requirements, and so forth. One can see successful examples of “process” oversight in the creation of the Financial Futures Market and the Options Market in the latter part of the 20th century.
A proposal for overseeing the assumption of risk by financial institutions has been put forward by Oliver Hart, an economics professor at Harvard, and Luigi Zingales, an economics professor at the University of Chicago, in the Spring 2010 copy of National Affairs, titled “Curbing Risk on Wall Street,” (http://www.nationalaffairs.com/publications/detail/curbing-risk-on-wall-street). I have threatened several times to present a critique of this proposal in one of my posts. Hopefully, I will accomplish this soon for the Hart/Zingales proposal, I believe, offers a lot for people to consider.
So, the world goes on. The financial reform package will be passed. Banking and finance will continue to thrive. Big banks will get bigger and there will be fewer and fewer small banks. Hedge funds and venture capital funds will, in general, continue to do what they do well. And, sometime in the future there will be another financial crisis.
Things are not different.
End note: for a “good read” check the lead article in the business section of the New York Times on Sunday about Ken Rogoff and Carman Reinhart and their book “This Time Is Different”: http://www.nytimes.com/2010/07/04/business/economy/04econ.html?_r=1&scp=1&sq=ken%20rogoff%20and%20carmen%20reinhart&st=cse.
In terms of the regulation of swaps, especially credit default swaps, “The once-feared swap provision has become toothless.”
The recent debate in Congress over the financial reform bill: A lot of “sound and fury signifying nothing.”
This legislation, the most comprehensive reform of the financial system since the 1930s, seems be passing into the history books with very little fanfare.
Sure, the financial institutions “huffed and puffed” and spent tons of money to fight Congress “every inch of the way.” But, what else did you expect. Perhaps you need to read a good economics book on “Game Theory”.
And, now?
Can’t you hear the executives at the big banks say, under their breath, “Well, the bill is passed, now we need to get back to business. Sure we spent a lot of money that could have gone elsewhere, but that is now history. In terms of where we are going to focus in the future, we just continue doing what we have been doing, finding the best way to do business and to make money. The bill, itself, will cause some inconvenience in some areas, hurt the smaller institutions more than the larger ones, but will not basically change what we are going to be doing.”
The article cited above states it all. JPMorgan acquired a large energy and metals trader last week. How will the financial reform bill impact this deal? After all, “Commodities are among a handful of derivatives still targeted…” by the bill.
The author of the article writes: “Blythe Masters, head of commodities at JPMorgan, said the bank already traded most energy through an affiliate and the law would ‘not substantially’ affect business.”
I have been arguing for months that the large banks had already moved beyond the reach of the regulations being discussed in Congress and that anything enacted by the legislators would be DOA, “dead on arrival.” The large banks started to reform and restructure themselves soon after the fall of 2008 when the financial crisis was at its peak! By the spring of 2009 these banks were well on the way to the future.
Congress, on the other hand, was mired in the past.
JPMorgan, to my mind, is one of the organizations leading us into the future. See, for example, my blog post “Follow the Dimon,” (http://seekingalpha.com/article/212236-follow-the-dimon). But, there are many others that are also out there pushing finance into the future.
Similar discussion are taking place in all areas of the finance field. Just this morning, the Wall Street Journal contained the article “What’s a ‘Prop’ Trader Now?” relating to the proprietary trading that many of the largest financial institutions engage in. (See, http://online.wsj.com/article/SB10001424052748703620604575349161970563670.html?mod=ITP_moneyandinvesting_0&mg=com-wsj.) The article addresses issues like, “What are ‘Prop’ traders?” and “How are banks redefining ‘Prop’ traders?” and “Where are ‘Prop’ traders located within the organization?”
The answers to these questions will help the larger financial institutions “churn out” billions of dollars in profits. Thus, the banks are willing to spend millions of dollars in hiring “the best and the brightest” lawyers and financial experts to come up with the answers. Congress is just not capable of matching the resources available to these publically-traded firms and so will lag behind what is going on in the private sector. To me, the information “gap” between the public sector and the private sector has never been larger.
The problem is that Congress is attempting to achieve “outcomes”. They want to keep banks from becoming “too big to fail” and to keep banks from taking on too much risk. Historically, we see that laws and regulations that seek “outcomes” are bound to fail because, specifying “outcomes” tells those being regulated what they have to “get around”, what they have to “evade.”
In this Age of Information, it has become exceedingly easy to “get around” laws and regulations and “evade” the restrictions imposed by the legislators and regulators. (See the series of posts I began on January 25, 2010, “Financial Regulation in the Information Age”: http://seekingalpha.com/article/184153-financial-regulation-in-the-information-age-part-a.)
Laws and regulations work better when they are aimed at processes, the way that the regulated firms do business. These kinds of rules and regulations have to do with information flow (corporate disclosure and transparency), how trades are made, how trades are constructed, margin requirements, and so forth. One can see successful examples of “process” oversight in the creation of the Financial Futures Market and the Options Market in the latter part of the 20th century.
A proposal for overseeing the assumption of risk by financial institutions has been put forward by Oliver Hart, an economics professor at Harvard, and Luigi Zingales, an economics professor at the University of Chicago, in the Spring 2010 copy of National Affairs, titled “Curbing Risk on Wall Street,” (http://www.nationalaffairs.com/publications/detail/curbing-risk-on-wall-street). I have threatened several times to present a critique of this proposal in one of my posts. Hopefully, I will accomplish this soon for the Hart/Zingales proposal, I believe, offers a lot for people to consider.
So, the world goes on. The financial reform package will be passed. Banking and finance will continue to thrive. Big banks will get bigger and there will be fewer and fewer small banks. Hedge funds and venture capital funds will, in general, continue to do what they do well. And, sometime in the future there will be another financial crisis.
Things are not different.
End note: for a “good read” check the lead article in the business section of the New York Times on Sunday about Ken Rogoff and Carman Reinhart and their book “This Time Is Different”: http://www.nytimes.com/2010/07/04/business/economy/04econ.html?_r=1&scp=1&sq=ken%20rogoff%20and%20carmen%20reinhart&st=cse.
Monday, July 5, 2010
Jobs and Skills: the Current Mismatch
For at least 18 months, I have been arguing that the United States economy is going through a transition period that is more than just a cyclical slowdown and recovery. My argument has been that the economy is going through a period of restructuring that will take an extended amount of time to work out all the changes that are necessary.
As a consequence, “blunt-edge” efforts to stimulate jobs by means of the fiscal policy of the federal government will not achieve a great deal of success.
The reason for this in many cases is that the fiscal stimulus of the past 50 years has caused companies to keep aging physical capital in use and has resulted in these companies hiring people to perform jobs related to “legacy” technology.
The evidence I have provided for this is the increasing amount of unused capacity in the manufacturing realm and the growth in the number of employable Americans that are under-employed. To be under-employed, one is either unemployed, not fully employed and looking for full-time work, or discouraged and not seeking a job.
I have argued that this is not unlike the 1930s when the United States economy was going through a transition period in which jobs and employment were shifting from rural and agricultural areas to cities and industrial areas. The restructuring that took place accelerated during World War II and did not really calm down until the 1950s and 1960s.
Two reports came out toward the end of last week that support my claim of an economy that is in the process of restructuring. The first was an article by Motoko Rich that appeared in the New York Times on Friday July 2, with the title “Jobs Go Begging as Gap is Exposed in Worker Skills.” (http://www.nytimes.com/2010/07/02/business/economy/02manufacturing.html?_r=1&scp=2&sq=motoko%20rich&st=cse) Rich writes that “Plenty of people are applying for the jobs. The problem, the companies say, is a mismatch between the kind of skilled workers needed and the ranks of the unemployed.” The subheading to the article reads that “Shifts in Manufacturing are Leaving Many as Unemployable.”
The second report came from the Labor Department on Friday, July 3. Although the unemployment rate declined in May to 9.5 % from 9.7% in April, this was because the labor force shrank as more people left the labor force than were added to payrolls: the labor force shrunk by 0.3% while the number of individuals employed dropped by only 0.2% (due to the loss in jobs connected with the collection of Census data).
The official statistics report that the “underemployment” rate has been in the 17% range for the past year or so. I estimate that, currently, about one out of every four or five individuals that are in the employable age group are under-employed. The reason is that there is a tremendous mis-match between what employers need to be competitive in the future and the pool of skills and experience that are available in the labor market. Products are being made differently now than they were several years ago and this trend will continue. The current downturn has provided additional justification for manufacturers to make the changes that they need to make.
Why do they need this added justification?
Well, over the past 50 years, every time there was a recession (and even in periods when there was not a recession), the federal government provided fiscal stimulus to get people “back-to-work.” Back-to-work, however, meant putting people back into jobs that they were in before the workers were laid off. This is what the government wanted to happen.
However, putting people back to work in “legacy” jobs did not contribute to modernization and improved productivity. It did increase employment and reduce unemployment which is what the federal government wanted to achieve.
Now, businesses can use the excuse of the extreme downturn in the economy to justify the changes in who is hired to meet the reality of changes in training, skill levels, and experience that have occurred. And, this transition will not be completed overnight.
We see the same thing in the use of physical capital in the United States. Since the 1960s, the capacity utilization of manufacturers has declined steadily. As with the increase in the underemployed, the employment of the physical capital in the United States has fallen over time.
In January 1965, American manufacturers were working at 89.4% of capacity. The next peak in manufacturing usage (capacity utilization is very cyclical) came in February 1973 at 88.8% of capacity. The following peaks were: December 1978 at 86.6% of capacity; January 1989 at 85.2% of capacity; December 1997 at 84.7% of capacity; and April 2007 at 81.7% of capacity.
Note that the troughs of the cycles in capacity utilization also fell since the 1960s. In December 1982, manufacturers in the United States worked at 70.9% of capacity and in June 2009, they worked at 68.2%. Currently, manufacturers are working at 74.1% of capacity.
In essence, businesses in the United States have been utilizing less and less human and physical capital over the past 50 years relative to the amounts of these productive factors that have been available. And, the policy makers just don’t seem to get it.
From Rich, in the article cited above, “Christina D. Romer, chairwoman of the Council of Economic Advisers, said the skills shortages reported by employers stem largely from a long-term structural shift in manufacturing, which should not be confused with the recent downturn. ‘I do think that manufacturing can come back to what it was before the recession,’ she said.” So, manufacturing will return to the new, lower level of capacity utilization that was achieved at its previous peak level, roughly 82% of capacity. And, this is good?
My guess is that capacity utilization will hit, maybe, 80% at the next peak. We are still talking about 20% of the manufacturing capital of the United States being underemployed, right in line with the 20% to 25% of employable labor in the United States being underemployed.
The fiscal stimulus proposed by “fundamentalist” Keynesian economists will not do the job. Additional, “blunt-edge” governmental expenditures may alleviate some of the current worker distress, but at the cost of postponing the adjustments that need to be made to restructure the economy, the restructuring that is now going on.
The problem with the “fundamentalist” Keynesian view is that it is constructed from a short term perspective. The basic attitude is that which is attributed to Keynes: “In the long run we are all dead.” This approach leads to a focus on only “current” problems. What is not explicitly stated is that we will deal with the longer-term problems when they become current problems.
The difficulty with this: the longer-term problems may require a different “medicine” than did the short-run problems.
Well, one could argue that the longer-term problems have become current. The short-term solution of forcing many companies to continue to employ people in “legacy” jobs and to continue to use “legacy” plant and equipment has resulted in higher and higher rates of worker under-employment and lower and lower rates of manufacturing capacity utilization.
Just more of the same does not seem to be an adequate answer.
As a consequence, “blunt-edge” efforts to stimulate jobs by means of the fiscal policy of the federal government will not achieve a great deal of success.
The reason for this in many cases is that the fiscal stimulus of the past 50 years has caused companies to keep aging physical capital in use and has resulted in these companies hiring people to perform jobs related to “legacy” technology.
The evidence I have provided for this is the increasing amount of unused capacity in the manufacturing realm and the growth in the number of employable Americans that are under-employed. To be under-employed, one is either unemployed, not fully employed and looking for full-time work, or discouraged and not seeking a job.
I have argued that this is not unlike the 1930s when the United States economy was going through a transition period in which jobs and employment were shifting from rural and agricultural areas to cities and industrial areas. The restructuring that took place accelerated during World War II and did not really calm down until the 1950s and 1960s.
Two reports came out toward the end of last week that support my claim of an economy that is in the process of restructuring. The first was an article by Motoko Rich that appeared in the New York Times on Friday July 2, with the title “Jobs Go Begging as Gap is Exposed in Worker Skills.” (http://www.nytimes.com/2010/07/02/business/economy/02manufacturing.html?_r=1&scp=2&sq=motoko%20rich&st=cse) Rich writes that “Plenty of people are applying for the jobs. The problem, the companies say, is a mismatch between the kind of skilled workers needed and the ranks of the unemployed.” The subheading to the article reads that “Shifts in Manufacturing are Leaving Many as Unemployable.”
The second report came from the Labor Department on Friday, July 3. Although the unemployment rate declined in May to 9.5 % from 9.7% in April, this was because the labor force shrank as more people left the labor force than were added to payrolls: the labor force shrunk by 0.3% while the number of individuals employed dropped by only 0.2% (due to the loss in jobs connected with the collection of Census data).
The official statistics report that the “underemployment” rate has been in the 17% range for the past year or so. I estimate that, currently, about one out of every four or five individuals that are in the employable age group are under-employed. The reason is that there is a tremendous mis-match between what employers need to be competitive in the future and the pool of skills and experience that are available in the labor market. Products are being made differently now than they were several years ago and this trend will continue. The current downturn has provided additional justification for manufacturers to make the changes that they need to make.
Why do they need this added justification?
Well, over the past 50 years, every time there was a recession (and even in periods when there was not a recession), the federal government provided fiscal stimulus to get people “back-to-work.” Back-to-work, however, meant putting people back into jobs that they were in before the workers were laid off. This is what the government wanted to happen.
However, putting people back to work in “legacy” jobs did not contribute to modernization and improved productivity. It did increase employment and reduce unemployment which is what the federal government wanted to achieve.
Now, businesses can use the excuse of the extreme downturn in the economy to justify the changes in who is hired to meet the reality of changes in training, skill levels, and experience that have occurred. And, this transition will not be completed overnight.
We see the same thing in the use of physical capital in the United States. Since the 1960s, the capacity utilization of manufacturers has declined steadily. As with the increase in the underemployed, the employment of the physical capital in the United States has fallen over time.
In January 1965, American manufacturers were working at 89.4% of capacity. The next peak in manufacturing usage (capacity utilization is very cyclical) came in February 1973 at 88.8% of capacity. The following peaks were: December 1978 at 86.6% of capacity; January 1989 at 85.2% of capacity; December 1997 at 84.7% of capacity; and April 2007 at 81.7% of capacity.
Note that the troughs of the cycles in capacity utilization also fell since the 1960s. In December 1982, manufacturers in the United States worked at 70.9% of capacity and in June 2009, they worked at 68.2%. Currently, manufacturers are working at 74.1% of capacity.
In essence, businesses in the United States have been utilizing less and less human and physical capital over the past 50 years relative to the amounts of these productive factors that have been available. And, the policy makers just don’t seem to get it.
From Rich, in the article cited above, “Christina D. Romer, chairwoman of the Council of Economic Advisers, said the skills shortages reported by employers stem largely from a long-term structural shift in manufacturing, which should not be confused with the recent downturn. ‘I do think that manufacturing can come back to what it was before the recession,’ she said.” So, manufacturing will return to the new, lower level of capacity utilization that was achieved at its previous peak level, roughly 82% of capacity. And, this is good?
My guess is that capacity utilization will hit, maybe, 80% at the next peak. We are still talking about 20% of the manufacturing capital of the United States being underemployed, right in line with the 20% to 25% of employable labor in the United States being underemployed.
The fiscal stimulus proposed by “fundamentalist” Keynesian economists will not do the job. Additional, “blunt-edge” governmental expenditures may alleviate some of the current worker distress, but at the cost of postponing the adjustments that need to be made to restructure the economy, the restructuring that is now going on.
The problem with the “fundamentalist” Keynesian view is that it is constructed from a short term perspective. The basic attitude is that which is attributed to Keynes: “In the long run we are all dead.” This approach leads to a focus on only “current” problems. What is not explicitly stated is that we will deal with the longer-term problems when they become current problems.
The difficulty with this: the longer-term problems may require a different “medicine” than did the short-run problems.
Well, one could argue that the longer-term problems have become current. The short-term solution of forcing many companies to continue to employ people in “legacy” jobs and to continue to use “legacy” plant and equipment has resulted in higher and higher rates of worker under-employment and lower and lower rates of manufacturing capacity utilization.
Just more of the same does not seem to be an adequate answer.
Wednesday, June 23, 2010
Follow the Dimon!
For months I have been arguing in my blog posts that the larger banks have already moved beyond the regulators although they have always been far in advance of the politicians. These latter two groups of people are attempting to create a regulatory system that will prevent the events of 2007 through 2009 from happening again.
Would somebody tell them that the big banks are somewhere else.
JPMorgan Chase announced some major changes in their top management structure yesterday. These changes, to me, are just the most visible sign that the banking of the future is going to be significantly different from the banking of the past. But, we’ll come back to this later on.
The management changes also confirm, to me, that Jamie Dimon is the pre-eminent banker in today’s world.
Why?
A long time ago I stopped looking at the “glow” of the person running things, the Chairman, President, or CEO, and I started concentrating on the people around the glorious leader. I found that the fact that the leader of an organization had very, very capable and experienced people around them was a better indicator of the quality of the person in charge than was his or her own sparkling image.
Top people have top people around them. In addition, winners help to make everyone around them perform better.
Jamie Dimon has these qualities.
I believe that Jack Welch also had them.
One person I had contacts with at one time who, I felt, didn’t have these qualities and was a disaster waiting to happen, was Donald Rumsfeld.
Jamie Dimon has a top notch team around him and is positioning them to take on the world. In my estimate, more than one of the individuals that are on this team will be a Chief Executive Officer of a major bank in the United States…or, the world.
Many people that Jack Welch had around him went on to lead major companies around the world.
But, back to the banking changes: JPMorgan is going off-shore!
The New York Times has it right, “JPMorgan Sets Sights Overseas,” (http://www.nytimes.com/2010/06/23/business/23bank.html?ref=business). Dimon has given out the mandate to his closest lieutenants “to start a global corporate banking business and scout out opportunities in Europe, Latin America and Asia.” Mr. Dimon, himself, has recently been in China, India, and Russia and wants to especially focus on these three BRIC countries as well as Brazil and also Vietnam, Indonesia, Malaysia, the Philippines and parts of Africa.
My suggestion: Watch what Mr. Dimon and JPMorgan do. My guess is that they will point the way to the future and will do a good job along the way!
But, what about American and Europe?
In terms of banking and finance, I am not sure the political and governmental leaders in these areas of the world know what they are doing. For one, as I have said over and over again, in terms of financial regulation…they are fighting the last war!
Politically, both areas are split and looking for direction. No one can tell at this time where “direction” will come from.
So, what better time than this to move to where the action is going to be!
If anything, the fiasco going on in Washington, D. C. is going to drive business and finance further off shore. The BRIC nations are becoming wealthier and more savvy in the world. They are also accumulating more power as will be in evidence in the upcoming G-20 meetings. But, as Mr. Dimon indicates, there is a lot more going on if one looks to the other countries he has highlighted in his recent statements.
Moving in this direction will involve acquisitions, something that JPMorgan has already started doing. To build itself into a larger presence in these markets in a timely fashion, the company will have to acquire significant other properties. JPMorgan Chase is going to get bigger.
And, Washington was concerned with the size of the banks in the United States that were “too big to fail” in 2008?
Furthermore, this doesn’t even get into one of my favorite subjects, the “quantification” of finance. What is going on with respect to the “quants” in JPMorgan? My guess is that there has been significant movement in this area as well over the past two years.
The future of banking?
Keep your eyes on the Dimon. I think you will find that it will be time well spent!
Would somebody tell them that the big banks are somewhere else.
JPMorgan Chase announced some major changes in their top management structure yesterday. These changes, to me, are just the most visible sign that the banking of the future is going to be significantly different from the banking of the past. But, we’ll come back to this later on.
The management changes also confirm, to me, that Jamie Dimon is the pre-eminent banker in today’s world.
Why?
A long time ago I stopped looking at the “glow” of the person running things, the Chairman, President, or CEO, and I started concentrating on the people around the glorious leader. I found that the fact that the leader of an organization had very, very capable and experienced people around them was a better indicator of the quality of the person in charge than was his or her own sparkling image.
Top people have top people around them. In addition, winners help to make everyone around them perform better.
Jamie Dimon has these qualities.
I believe that Jack Welch also had them.
One person I had contacts with at one time who, I felt, didn’t have these qualities and was a disaster waiting to happen, was Donald Rumsfeld.
Jamie Dimon has a top notch team around him and is positioning them to take on the world. In my estimate, more than one of the individuals that are on this team will be a Chief Executive Officer of a major bank in the United States…or, the world.
Many people that Jack Welch had around him went on to lead major companies around the world.
But, back to the banking changes: JPMorgan is going off-shore!
The New York Times has it right, “JPMorgan Sets Sights Overseas,” (http://www.nytimes.com/2010/06/23/business/23bank.html?ref=business). Dimon has given out the mandate to his closest lieutenants “to start a global corporate banking business and scout out opportunities in Europe, Latin America and Asia.” Mr. Dimon, himself, has recently been in China, India, and Russia and wants to especially focus on these three BRIC countries as well as Brazil and also Vietnam, Indonesia, Malaysia, the Philippines and parts of Africa.
My suggestion: Watch what Mr. Dimon and JPMorgan do. My guess is that they will point the way to the future and will do a good job along the way!
But, what about American and Europe?
In terms of banking and finance, I am not sure the political and governmental leaders in these areas of the world know what they are doing. For one, as I have said over and over again, in terms of financial regulation…they are fighting the last war!
Politically, both areas are split and looking for direction. No one can tell at this time where “direction” will come from.
So, what better time than this to move to where the action is going to be!
If anything, the fiasco going on in Washington, D. C. is going to drive business and finance further off shore. The BRIC nations are becoming wealthier and more savvy in the world. They are also accumulating more power as will be in evidence in the upcoming G-20 meetings. But, as Mr. Dimon indicates, there is a lot more going on if one looks to the other countries he has highlighted in his recent statements.
Moving in this direction will involve acquisitions, something that JPMorgan has already started doing. To build itself into a larger presence in these markets in a timely fashion, the company will have to acquire significant other properties. JPMorgan Chase is going to get bigger.
And, Washington was concerned with the size of the banks in the United States that were “too big to fail” in 2008?
Furthermore, this doesn’t even get into one of my favorite subjects, the “quantification” of finance. What is going on with respect to the “quants” in JPMorgan? My guess is that there has been significant movement in this area as well over the past two years.
The future of banking?
Keep your eyes on the Dimon. I think you will find that it will be time well spent!
Tuesday, June 22, 2010
The Problem is "Out There"! It's China!
The quote of Stephen Covey that continues to resonate with me is "As long as you think the problem is out there, that very thought is the problem."
With all the fuss over the movement by the Chinese to allow the value of their currency to rise we hear, once again in the background, that the real problem is that the imbalances in the world are really a consequence of “an entrenched savings excess” in China. (See the article by George Magnus, “We Need More from China than a Flexible Renminbi,” http://www.ft.com/cms/s/0/4f19ced4-7d4a-11df-a0f5-00144feabdc0.html.)
There we have it!
And, the support for this theory goes as far as Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve System, who came up with this idea to provide Alan Greenspan with an excuse to keep interest rates excessively low in the earlier years of the 2000s.
The problem is “Out There”!
Those Chinese just save too much! Let them be like the Americans who reduced their savings to close to around one percent of disposable income earlier this decade. The Chinese bought a large proportion of the bonds going to finance the huge deficits of the United States government and this kept interest rates so low that the Federal Reserve could reduce their target interest rates to levels that created a bubble in the United States housing market.
As Magnus writes, the Chinese do have an unreformed rural sector, an immature social security and financial system and a one-child policy. But, China is transforming. It is just not doing it at the pace that the Western world would like it to in order to reduce or eliminate the imbalances that exist internationally.
The Chinese, however, are not going to change their social policy overnight. This is one of their “no-no’s”! They saw what happened in Russia and Eastern Europe as the social order unraveled when the Communist governments in these areas fell. They vowed to keep a lid on things, culturally, as China modernized. They will not back off this controlled approach as they move toward a state capitalism and a society that is more open to the world.
But, this is not what created the huge government budget deficits in the United States. The total amount of United States debt outstanding rose at a compound rate of over 7% from early in the 1960s through the end of 2008. This was not the fault of the Chinese!
Nor is it the solution to the low personal savings rates in the United States and the huge government budget deficits going forward. The personal savings rate in the United States stayed above 7% for most of the period between the late 1950s into the late 1980s. It exceeded 10% at times!
What eventually got to the American saver was the steady erosion of the real value of the savings put aside during this time. And, as the American saver moved into the 1990s, the personal savings rate began to fall and continued to fall into the 2000s. Consumer prices in the United States rose at a compound rate of around 4% from January 1961 through the summer of 2008. The purchasing power of a 1961 dollar dropped during this time to about $0.15.
If anything may accelerate the decline in the personal savings rate in China it may be the rising rate of inflation that is being experienced there. If the real value of savings takes a precipitous drop, even the rural Chinese may begin to adjust their behavior.
The real problem in this picture is the massive amount of United States debt that is outstanding. And, the amount of debt that is outstanding is the fault of no one but the United States. But, this problem puts a lot of pressure on other countries, especially on China.
China holds about 70 percent of its foreign exchange reserves in dollars, mostly in United States Treasury securities. This accumulation began in the 1990s and accelerated into the 2000s. The United States dollar was the reserve currency of the world and United States Treasury securities were the most secure investment around in terms of risk.
I remember working with a group from China in the early 1990s that represented Chinese pension funds. This discussion took place at the University of Pennsylvania. I was not teaching at the time, I was the president and CEO of a bank.
Chinese pension funds had a very large amount of money, yet because they could only invest on Mainland China they had limited capabilities of earning a decent return on their monies and were very limited in terms of their ability to diversify their investment holdings. This group was investigating investing pension fund monies “off-shore” and they were interested in foreign exchange risk and how this risk could be hedged. And, these discussions were a part of the general discussion going on in China at the time about investing more and more of their monies and international reserves in the rest of the world.
The point is that the early 1990s represented a time in which China was opening up and investigating how it could participate in global financial markets. Being very cautious, the Chinese were learning about how to diversify into the world but keep its risk exposure low both in term of credit risk and foreign exchange risk. I don’t see much of a change in this attitude at the present time.
Magnus mentions, in his article, that because of China’s creditor status it must play a role in helping to fix the global financial imbalances. Specifically, he argues that China cannot “back away” from these world imbalances—as the United States did in the 1920s and the Japanese did in the 1980s—because, in the end, backing away will neither help the world, or themselves.
My guess is that the Chinese will not “back away” and “dump” United States Treasury securities. This is one of the reasons why the Chinese do not want to see the value of the Yuan rise too rapidly. A “quicker revaluation would act as a stealth monetary tightening not only in China but also the US.” This is because it would have a negative effect on US equity prices and also result in higher US interest rates. (See the Lex column in the Financial Times: http://www.ft.com/cms/s/3/9db857ea-7d45-11df-a0f5-00144feabdc0.html.)
However, President Obama’s administration and the United States Congress continues to press for China to change the behavior of its government and the savings habits of its people. Yet, many of the major imbalances in the world today result from the undisciplined behavior of the United States over the past fifty years or so. The huge amounts of United States government debt outstanding are not the result of the government of China or the Chinese people. Why, then, should the Chinese bear the brunt of any adjustment that is to take place?
As long as the United States government and the people of the United States think the problem is out there, the problems and imbalances will not be resolved. The only one we can control is ourselves, so if anything is going to be accomplished, we are going to have to do it…not the Chinese.
With all the fuss over the movement by the Chinese to allow the value of their currency to rise we hear, once again in the background, that the real problem is that the imbalances in the world are really a consequence of “an entrenched savings excess” in China. (See the article by George Magnus, “We Need More from China than a Flexible Renminbi,” http://www.ft.com/cms/s/0/4f19ced4-7d4a-11df-a0f5-00144feabdc0.html.)
There we have it!
And, the support for this theory goes as far as Ben Bernanke, Chairman of the Board of Governors of the Federal Reserve System, who came up with this idea to provide Alan Greenspan with an excuse to keep interest rates excessively low in the earlier years of the 2000s.
The problem is “Out There”!
Those Chinese just save too much! Let them be like the Americans who reduced their savings to close to around one percent of disposable income earlier this decade. The Chinese bought a large proportion of the bonds going to finance the huge deficits of the United States government and this kept interest rates so low that the Federal Reserve could reduce their target interest rates to levels that created a bubble in the United States housing market.
As Magnus writes, the Chinese do have an unreformed rural sector, an immature social security and financial system and a one-child policy. But, China is transforming. It is just not doing it at the pace that the Western world would like it to in order to reduce or eliminate the imbalances that exist internationally.
The Chinese, however, are not going to change their social policy overnight. This is one of their “no-no’s”! They saw what happened in Russia and Eastern Europe as the social order unraveled when the Communist governments in these areas fell. They vowed to keep a lid on things, culturally, as China modernized. They will not back off this controlled approach as they move toward a state capitalism and a society that is more open to the world.
But, this is not what created the huge government budget deficits in the United States. The total amount of United States debt outstanding rose at a compound rate of over 7% from early in the 1960s through the end of 2008. This was not the fault of the Chinese!
Nor is it the solution to the low personal savings rates in the United States and the huge government budget deficits going forward. The personal savings rate in the United States stayed above 7% for most of the period between the late 1950s into the late 1980s. It exceeded 10% at times!
What eventually got to the American saver was the steady erosion of the real value of the savings put aside during this time. And, as the American saver moved into the 1990s, the personal savings rate began to fall and continued to fall into the 2000s. Consumer prices in the United States rose at a compound rate of around 4% from January 1961 through the summer of 2008. The purchasing power of a 1961 dollar dropped during this time to about $0.15.
If anything may accelerate the decline in the personal savings rate in China it may be the rising rate of inflation that is being experienced there. If the real value of savings takes a precipitous drop, even the rural Chinese may begin to adjust their behavior.
The real problem in this picture is the massive amount of United States debt that is outstanding. And, the amount of debt that is outstanding is the fault of no one but the United States. But, this problem puts a lot of pressure on other countries, especially on China.
China holds about 70 percent of its foreign exchange reserves in dollars, mostly in United States Treasury securities. This accumulation began in the 1990s and accelerated into the 2000s. The United States dollar was the reserve currency of the world and United States Treasury securities were the most secure investment around in terms of risk.
I remember working with a group from China in the early 1990s that represented Chinese pension funds. This discussion took place at the University of Pennsylvania. I was not teaching at the time, I was the president and CEO of a bank.
Chinese pension funds had a very large amount of money, yet because they could only invest on Mainland China they had limited capabilities of earning a decent return on their monies and were very limited in terms of their ability to diversify their investment holdings. This group was investigating investing pension fund monies “off-shore” and they were interested in foreign exchange risk and how this risk could be hedged. And, these discussions were a part of the general discussion going on in China at the time about investing more and more of their monies and international reserves in the rest of the world.
The point is that the early 1990s represented a time in which China was opening up and investigating how it could participate in global financial markets. Being very cautious, the Chinese were learning about how to diversify into the world but keep its risk exposure low both in term of credit risk and foreign exchange risk. I don’t see much of a change in this attitude at the present time.
Magnus mentions, in his article, that because of China’s creditor status it must play a role in helping to fix the global financial imbalances. Specifically, he argues that China cannot “back away” from these world imbalances—as the United States did in the 1920s and the Japanese did in the 1980s—because, in the end, backing away will neither help the world, or themselves.
My guess is that the Chinese will not “back away” and “dump” United States Treasury securities. This is one of the reasons why the Chinese do not want to see the value of the Yuan rise too rapidly. A “quicker revaluation would act as a stealth monetary tightening not only in China but also the US.” This is because it would have a negative effect on US equity prices and also result in higher US interest rates. (See the Lex column in the Financial Times: http://www.ft.com/cms/s/3/9db857ea-7d45-11df-a0f5-00144feabdc0.html.)
However, President Obama’s administration and the United States Congress continues to press for China to change the behavior of its government and the savings habits of its people. Yet, many of the major imbalances in the world today result from the undisciplined behavior of the United States over the past fifty years or so. The huge amounts of United States government debt outstanding are not the result of the government of China or the Chinese people. Why, then, should the Chinese bear the brunt of any adjustment that is to take place?
As long as the United States government and the people of the United States think the problem is out there, the problems and imbalances will not be resolved. The only one we can control is ourselves, so if anything is going to be accomplished, we are going to have to do it…not the Chinese.
Monday, June 21, 2010
China Is In The Game
China wants to play in the game. Yes, it would like to dominate the game, but that is for another time. For the present, China wants to be a player. I have written this constantly throughout my blogging career and I see no reason to change my opinion at this point.
China wants to play in the game and to do so its leaders realize that it must be a part of the game and not absent from it. But, remember two things: first, China will not do anything that it thinks might be harmful to itself in the long run; and second, China will always move in a way that “saves face.” Given these two conditions, China will be “in the game.”
The weekend news about China’s move on its currency is a case in point. The move was taken at China’s initiative. It seemed to catch the rest of the world by surprise. The move followed weeks of discussion about the possibility that China would not change the value of its currency in the near term.
China timed its move according to its dictates and not those of other nations.
Furthermore, the move pre-empts any discussion or actions by members of the G-20 at its June 26-27 meeting to highlight China’s unwillingness to play ball with the other major nations that will be in attendance. Now, the rest of the G-20 must re-boot their strategies relative to the agenda of the upcoming meeting.
China must see this as beneficial to itself and believe that moving at this time “saves face” because the news was done on its terms and not those of other countries in the world. It is keeping itself in the game.
However, China does not want events to get ahead of its plans. Although the announcement came on Saturday, when the market opened on Monday the value of the yuan was approximately 6.83 yuan to the dollar, roughly the same as it closed on Friday. By Monday afternoon, however, the yuan was trading around 6.8015 to the dollar, the highest level it has been in the modern era.
The point here is that China wants any appreciation in the value of the yuan to be incremental and not discrete. That is, movements in the yuan will tend to be more like a slow crawl and not like a discrete jump or leap. The leaders in China do not want to encourage speculators or huge currency inflows.
The signal to investors is that the value of the yuan may change but don’t expect wide swings. This is just not the way the Chinese do business.
But, I think, there is a bigger story going on here. The bigger story includes Russia and India…so we have three of the four BRIC nations as a part of what is going on. President Obama and his administration are making a concerted effort to be a part of the trajectory taking these countries into a prominent position in the world. All three of these countries are engaging each other, and talking with each other, visiting each other, and doing things with each other.
Chinese leaders have come to America and American leaders have gone to China.
New contacts with Russia show promise. Last year, President Obama called for a reset in relations with Russia. The countries have now signed a nuclear arms reduction treaty, agreed to increase cooperation in Afghanistan, and Russia has supported United States sanctions against Iran. This week President Medvedev comes to Washington to discuss business and then will visit Silicon Valley to meet with leaders in the technology field. Medvedev would like to encourage technology areas similar to Silicon Valley in Russia.
Leaders in India also are responding to invitations from the Obama administration to engage in dialogue and improved communications between India and the United States. Of these three BRIC nations, India has the longest solid ties with the United States and the greatest personal bond to see that these ties become stronger.
Not only are these three countries becoming relatively stronger in the world pecking order, but are the important reason why discussions about world business and foreign trade need to work in the larger Group of 20 nations rather than in the smaller groups that have been so prominent in the past.
Add on top of this the economic weaknesses experienced in the United States and Europe which have allowed these three, China, Russia, and India, to gain relative to “the West” faster than they would have if the financial collapse in these former areas had not occurred. These three nations are not going to back off their ascent in the world power scramble just because the United States and Europe are facing some “uncomfortable” economic weaknesses.
Furthermore, Europe has its own internal contradictions to deal with. Leadership in Europe is close to zero and the political problems that must be resolved there are almost overwhelming. And, while Europe attempts to get its house in order…the rest of the world moves on.
Brazil, the other BRIC, seems to be laying bricks lately. The current president, Luiz Inảcio Lula da Silva seems more interested in playing around with the leaders of countries at odds with the United States rather than entering into more mature relationships with the rest of the emerging world. Enough said.
What is vitally important for world trade and finance is to have these major countries talking with one another and learning about how they can work together to create a world in which all can prosper. World trade will not exist if it just benefits one or two countries.
The emerging nations are doing just that…emerging. These countries must be an important part of the world of the future. Keeping these nations down and causing resentments in a world where there are no channels for communication is not the way to build a richer and more vibrant world to live in.
The crucial thing is learning how to deal with each other. As I mentioned above, the Chinese will not make moves that will harm themselves in the long run and when they move they will do so in a way that does not make them look bad. Can we in the United States accept these two behavioral traits that seem so important to the Chinese or will we become so impatient and try and impose our self-importance on them?
Certainly, leaders in the United States cannot become “doormats” that others can just walk over. But, the time seems right for talking, for keeping channels open, for cooperation within the competitive framework, and for learning how to work with each other, accepting the quirks and psychological needs of others.
China will not always internally do the things we in the United States think that they should do…especially in some areas like human rights. We should not be silent on these things. But, I believe the world still has more to gain by building cooperation over the longer run than it does by breaking off ties. I believe that the recent economic moves by China confirm this. I believe that the leaders of China truly want to be in the game and will act accordingly.
China wants to play in the game and to do so its leaders realize that it must be a part of the game and not absent from it. But, remember two things: first, China will not do anything that it thinks might be harmful to itself in the long run; and second, China will always move in a way that “saves face.” Given these two conditions, China will be “in the game.”
The weekend news about China’s move on its currency is a case in point. The move was taken at China’s initiative. It seemed to catch the rest of the world by surprise. The move followed weeks of discussion about the possibility that China would not change the value of its currency in the near term.
China timed its move according to its dictates and not those of other nations.
Furthermore, the move pre-empts any discussion or actions by members of the G-20 at its June 26-27 meeting to highlight China’s unwillingness to play ball with the other major nations that will be in attendance. Now, the rest of the G-20 must re-boot their strategies relative to the agenda of the upcoming meeting.
China must see this as beneficial to itself and believe that moving at this time “saves face” because the news was done on its terms and not those of other countries in the world. It is keeping itself in the game.
However, China does not want events to get ahead of its plans. Although the announcement came on Saturday, when the market opened on Monday the value of the yuan was approximately 6.83 yuan to the dollar, roughly the same as it closed on Friday. By Monday afternoon, however, the yuan was trading around 6.8015 to the dollar, the highest level it has been in the modern era.
The point here is that China wants any appreciation in the value of the yuan to be incremental and not discrete. That is, movements in the yuan will tend to be more like a slow crawl and not like a discrete jump or leap. The leaders in China do not want to encourage speculators or huge currency inflows.
The signal to investors is that the value of the yuan may change but don’t expect wide swings. This is just not the way the Chinese do business.
But, I think, there is a bigger story going on here. The bigger story includes Russia and India…so we have three of the four BRIC nations as a part of what is going on. President Obama and his administration are making a concerted effort to be a part of the trajectory taking these countries into a prominent position in the world. All three of these countries are engaging each other, and talking with each other, visiting each other, and doing things with each other.
Chinese leaders have come to America and American leaders have gone to China.
New contacts with Russia show promise. Last year, President Obama called for a reset in relations with Russia. The countries have now signed a nuclear arms reduction treaty, agreed to increase cooperation in Afghanistan, and Russia has supported United States sanctions against Iran. This week President Medvedev comes to Washington to discuss business and then will visit Silicon Valley to meet with leaders in the technology field. Medvedev would like to encourage technology areas similar to Silicon Valley in Russia.
Leaders in India also are responding to invitations from the Obama administration to engage in dialogue and improved communications between India and the United States. Of these three BRIC nations, India has the longest solid ties with the United States and the greatest personal bond to see that these ties become stronger.
Not only are these three countries becoming relatively stronger in the world pecking order, but are the important reason why discussions about world business and foreign trade need to work in the larger Group of 20 nations rather than in the smaller groups that have been so prominent in the past.
Add on top of this the economic weaknesses experienced in the United States and Europe which have allowed these three, China, Russia, and India, to gain relative to “the West” faster than they would have if the financial collapse in these former areas had not occurred. These three nations are not going to back off their ascent in the world power scramble just because the United States and Europe are facing some “uncomfortable” economic weaknesses.
Furthermore, Europe has its own internal contradictions to deal with. Leadership in Europe is close to zero and the political problems that must be resolved there are almost overwhelming. And, while Europe attempts to get its house in order…the rest of the world moves on.
Brazil, the other BRIC, seems to be laying bricks lately. The current president, Luiz Inảcio Lula da Silva seems more interested in playing around with the leaders of countries at odds with the United States rather than entering into more mature relationships with the rest of the emerging world. Enough said.
What is vitally important for world trade and finance is to have these major countries talking with one another and learning about how they can work together to create a world in which all can prosper. World trade will not exist if it just benefits one or two countries.
The emerging nations are doing just that…emerging. These countries must be an important part of the world of the future. Keeping these nations down and causing resentments in a world where there are no channels for communication is not the way to build a richer and more vibrant world to live in.
The crucial thing is learning how to deal with each other. As I mentioned above, the Chinese will not make moves that will harm themselves in the long run and when they move they will do so in a way that does not make them look bad. Can we in the United States accept these two behavioral traits that seem so important to the Chinese or will we become so impatient and try and impose our self-importance on them?
Certainly, leaders in the United States cannot become “doormats” that others can just walk over. But, the time seems right for talking, for keeping channels open, for cooperation within the competitive framework, and for learning how to work with each other, accepting the quirks and psychological needs of others.
China will not always internally do the things we in the United States think that they should do…especially in some areas like human rights. We should not be silent on these things. But, I believe the world still has more to gain by building cooperation over the longer run than it does by breaking off ties. I believe that the recent economic moves by China confirm this. I believe that the leaders of China truly want to be in the game and will act accordingly.
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