vyvu

China’s $463 billion bail-out of local governments last week gave a good indication of how big its coming financial crisis will be — about 1.5 times bigger than America’s.

It became clear last week that China has probably not dodged the financial crisis at all, after Beijing quietly bailed out local government to the tune of $463 billion.

Adjusted for the size of its economy, that rescue package is one-and-a-half times bigger than the Tarp bailout. That is particularly worrying, according to Dylan Grice, a global strategist at Societe Generale. “If we calibrate the magnitude of the economic crisis with the size of the bail-out, one-and-a-half Tarps implies a financial crisis one-and-a-half times the order of magnitude of 2008.”

The bail-out is aimed at cleaning up the vast pile bad loans made to local government financing vehicles, which were responsible for stimulus spending on infrastructure and development programmes. Grice expects the government will deal with them in the same way it recapitalised its banking industry after 1998, which has led some to assume the problem has been solved.

That might be wishful thinking. To understand the possible effects of China’s actions, Grice draws on an article by Black Swan author Nassim Taleb and Mark Blythe in the recent issue of Foreign Affairs, in which the two authors draw comparisons between the global financial crisis and the uprisings in North Africa and the Middle East.

“The critical issue in both cases is the artificial suppression of volatility — the ups and downs of life — in the name of stability,” they wrote. “What the world is witnessing in Tunisia, Egypt, and Libya is simply what happens when highly constrained systems explode.”

The same goes for China’s bailouts, argues Grice. It has succeeded in stalling its own crisis for so long only because it is more effective than almost any other country at exerting control over its economy. China can keep dancing for a while longer, but at some point the music has to stop.

This is nothing new, of course. Grice argues that monetary policy committees worldwide played a huge role in the crisis by setting interest rates at artificially low rates instead of seeking to match the “natural” rate of interest — which is roughly the same level as economic growth, whereby the supply of risk capital matches demand.

A look at historic rates shows clearly that all of the countries worst-affected by the crisis maintained interest rates far below the natural rate for years. In Ireland, rates were more than 10% below the equilibrium point in the early part of the last decade, while in the US they bottomed out at about 3% below the natural rate in around 2005.

 

“Surely enough, their economies boomed as the demand for risk capital rose. Why would it do otherwise?” asked Grice in the report, titled China’s Great Suppression. “But since the price of capital was suppressed by these wise committees, rates weren’t allowed to rise to their natural levels, so there was no increase in the supply of capital. Who would supply the searing demand for risk capital these wise central bankers were unleashing? Why, the wizards in the financial system!”

We all know how that worked out. Governments did a good job of suppressing asset-price inflation by letting the banks create a massive round of credit inflation. None of them, however, did as good a job as China. By Grice’s reckoning, China’s natural rate of interest is roughly 11.6% higher than its actual rate today.

Suppressing rates is politically expedient in western economies, where governments tend to be judged on extremely short-term measures, but China has no such worries. Indeed, one of its great advantages has been its ability to pursue necessary but unpopular policies without having to worry about the next election cycle. But China is juggling knives.

It might not be accountable in the western, democratic sense, but China’s leaders know that an unhappy population will take to the streets and could even topple the government. The trick to avoiding that is to make sure the people are happy, which means rich. But China could be paying a huge cost for the sake of suppressing inflation.

“It has upped the ante,” said Grice. “While we can’t predict where complex systems will go, we know that the longer their volatility is artificially suppressed, the more emphatic will be its release when it does come. It is more likely that China has one-and-a-half times (and counting) the 2008 financial crisis ahead of it.”

 

© Haymarket Media Limited. All rights reserved.

So, what do you think about vn?

What will happen to Vietnam after a series of strong actions at the beginning of 2011?

Vietnam has started the year of 2011 with a very strong signal that the most important mission of the country this year is to curb inflation at one-digit increase. Accordingly, a number of key monetary measures have been implemented to achieve the goal, which can be listed out as below.

i)                    Revising 2011’s GDP growth target from 7%-7.5% down to 6.5%-7%.

ii)                   Restricting credit growth of this year at 20% and lending to non-productive sector not to exceed 22% at the middle of the year and to be reduced to 16% by the year-end.

iii)                 Increasing base rate from 8% to 9% to pull money from circulation and therefore reducing economic growth and inflation pressure.

iv)                 More restriction on loan to deposit ratio and higher provision of lending as per the new regulation of prudential ratios, which come into effect late last year, have pushed banks into the situation of eagerly looking for funding from clients rather than other banks for their lending activity.

v)                  Removing the cap of lending interest rate which led to higher interest rate due to the credit growth restriction policy. On the other hand, State Bank has unofficially capped the mobilization interest rate of commercial banks to support lending to productive sectors and efficient businesses particularly of export for sustainable economic growth.

vi)                 Limiting the types of companies that are qualified for loans in foreign currencies to avoid FX high demand at certain points of time.

vii)               Depreciating VND against USD to have the rate in line with the market.

viii)              Inspecting the forex business of unofficial and official markets to prevent the market from being speculated.

ix)                 Allowing negotiable forex forward rates with the tenors from 3 to 12 months to provide flexibility to the forex transactions.

x)                  Prohibiting trading of gold bar by jewelry stores to lower the forex demand for gold import, which reduces the volatility of the forex market.

I do believe the recent regulations in banking will bring a number of IMPORT companies to death or temporary termination, ending a cycle of the economy about Q3 this year, and then it will start another economic cycle expectedly in Q4. Economically suffering in a certain period of time is unavoidable but it will bring about the soft landing of the economy, as a trade-off, in a longer period. Inflation is expected to be controlled within one digit as targeted and the economy of Vietnam will be more sustainable starting from end of this year.

The key rationales, I believe, are the strict enforcement of regulations and a number of measures, instead of single and situational measures as previously, have been taken.

Let’s take a look at the trade balance of Vietnam for the past number of years. The balance was mainly in deficit situation. Every year we experienced the depreciation of VND versus USD but the import volume kept rising and regularly higher than export. Last year, the trade balance was in deficit at US$12.4 billion with the import turnover at US$84 billion, 15% higher than export. Although the official depreciation of VND against USD was approximately 8%, not to mention the higher unofficial depreciation in black market, import volume still kept growing. The rationale is these importers were able to obtain financing in USD to lower borrowing cost, and then include VND depreciation in prices to end-buyers, which in turns caused inflation even higher than expected (11.75% versus 8%).

This year, a number of measures, not a single or a few ones as before, have been taken to address the inflation. Among them were the tightening credit policy and stricter regulations of prudential ratios in banking, which brought about higher interest rate, the action to depreciate VND, the efforts to reduce the dollarization and gold trading, and the restriction on foreign currency lending, which resulted in a very bad situation to importers.

With the current VND lending interest rate over 20% and about 8% depreciation of VND against USD last year, not many importers can survive and therefore it will likely  temporarily stop or end their businesses. At the time of the effectiveness of mentioned regulations, interest rate is expected to hike further until importers and companies with low profit cannot stand. As a result, borrowing demand will decrease, which in return cools down the interest rate to a level that, again, attracts businesses to borrow money for doing business. These events will likely cause the economic cycle to end expected in Q3 this year and bring another cycle back after that.

Commercial banks in Vietnam used to make huge profit from lending thanks to low provision requirement and forex business due to the existence of both official and unofficial forex markets at the same time. The rates of return this year of commercial banks tend to be lower and therefore the banks are now complaining and challenging the capacity of State Bank of Vietnam under the new leader. In my opinion, the State Bank has taken a set of right measures to cure the illness of the economy and prevent it from a possible shock. Never has the economy experienced such a strict enforcement of regulations. Commercial Banks were treated so nice and easy that they now need to be completely fixed in order to avoid severe pains in the long run.

I do not know, however, whether the government targets to tackle the root of the problem which is to raise long-term confidence in VND.

We will experience how Vietnamese economy will be from its recent policies over the next few months.

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