Monday, 24 December, 2012

SiMOn JOhnSOn

Here’s an odd prediction for the comingyear: 2013 will be a watershed for financialreform. true, while the global financial cri-sis erupted more than four years ago, andthe Dodd-Frank financial reforms wereadopted in the United states back in 2010,not much has changed about how Wallstreet operates – except that the large firmshave become bigger and more powerful. Yetthere are reasons to expect real progress inthe new year.

the Us Federal Reserve is finally shift-ing its thinking. In a series of majorspeeches this fall, Governor Dan tarullomade the case that the problem of “too bigto fail” financial institutions remains withus. We need to take additional measures toreduce the level of systemic risk – includinglimiting the size of our largest banks. Newsreports indicate that the Fed has alreadystarted saying no to some bank mergers.

At the same time, the Us Federal De-posit Insurance Corporation has become abastion of sensible thinking on financial-sector issues. In part, this is because theFDIC is responsible for cleaning up themess when financial-sector firms fail, so itssenior officials have a strong incentive toprotect its insurance fund by preventingrisks from getting out of control. the FDICis showing intellectual leadership as well asorganizational capabilities – Vice Chairmantom Hoenig’s speeches are a must-read.

Wall street is pushing back, of course.But the rolling series of scandals surround-ing global megabanks makes it difficult foranyone to keep a straight face when execu-tives insist that our largest banks mustmaintain their current scale and scope. Do

we need HsBC to facilitate global moneylaundering? Do we need Barclays and UBsto manipulate Libor (a key benchmark forinterest rates around the world)? Do weneed still more losses at poorly run tradingoperations for JP Morgan Chase?

the pro-bank lobby groups are posi-tioning themselves to argue that the newresolution powers under Dodd-Frank haveended the too-big-to-fail problem, and wecan expect a public-relations drive in this di-rection early in the new year. But the con-sensus view at the most recent meeting ofthe FDIC’s systemic Resolution AdvisoryCommittee (of which I am a member) wasthat this claim should not be taken seri-ously. Under Dodd-Frank, it is arguablyeasier for the FDIC to handle the failure ofa single large financial institution than itwas in pre-Dodd-Frank days. But what iftwo or three or seven firms are all in troubleat the same time?

the answer, as former Fed ChairmanPaul Volcker implied at the meeting, is thatwe would be right back where we started –in the panic and frozen credit markets thatfollowed the collapse of Lehman Brothers inseptember 2008. Indeed, the idea that sub-stantial shocks could soon hit the Us finan-cial system is not far-fetched. the Europeandebt crisis, for example, remains far frombeing resolved. A significant sovereign-debtrestructuring there would bring down Eu-ropean banks and potentially damage Usbanks – as well as financial institutionsaround the world.

Meanwhile, the continuing problems atEuropean banks are a stark reminder thatoperating highly leveraged, thinly capital-ized firms is incredibly risky. And the regu-latory failures in Europe – consider the

German Landesbanks, for example – willbecome only more obvious in the comingmonths. Creating a common supervisoryauthority will mean nothing unless it canclean up the mess created by the existing su-pervisors. And that cleanup will exposemore of the rot in banks’ current operations.

the need for banks to finance them-selves with more equity and relatively lessdebt will be the focus of one of the mainpublishing events in economics in 2013.Anat Admati and Martin Hellwig’s theBankers’ New Clothes: What’s Wrong withBanking and What to Do About it? will ap-pear officially in March, but advance copiesare already being closely read in leadingcentral banks. Bankers everywhere will rushto read it before their regulators do.

the road to the ongoing financial and

economic crisis was built on a foundation ofintellectual capture: not only regulators, butacademics, too, became captivated by mod-ern finance and its methods. Admati andHellwig are at the vanguard of the counter-revolution, challenging the great myths ofbanking head-on.

Do we need financial institutions to beso highly leveraged (that is, carrying somuch debt relative to equity)? No, theyargue. If banks of all kinds were financedwith more equity, they would have strongerbuffers to absorb losses. Both the equity andthe debt issued by well-capitalized bankswould be safer – and therefore cheaper.

Bankers want to be so highly leveragedfor a simple reason: implicit governmentguarantees mean that they get the upsidewhen things go well, while the downside is

someone else’s problem. Contrary tobankers’ claims, this is not a good arrange-ment for society. Admati and Hellwig areconfronting the bankers and their allies inno uncertain terms, grounding their argu-ment in deep financial thinking, yet writingfor a broad audience. Whatever else hap-pens in 2013, we can be sure that they willnot win the Goldman sachs Business Bookof the Year award.

simon Johnson, a former chief econo-mist of the IMF, is a professor at MIt sloan,a senior fellow at the Peterson Institute forInternational Economics, and co-founder ofa leading economics blog, the Baseline sce-nario. He is the co-author, with James Kwak,of White House Burning: the Founding Fa-thers, our National Debt, and Why It Mat-ters to You. Courtesy ProjeCt syndiCate

A GAry ShillinG

Most of us still look atChina, the world’s second-largest economy, as theundisputed leader amongmajor developing coun-

tries. In the long run, however, I’m bettingon India to emerge as the more significantglobal economy.

those who are dazzled by China oftenforget that much of the rapid growth before2008 was caused by the shift of global man-ufacturing from Europe and the U.s., notby domestic-oriented activity. China’seconomy remains export-driven, with con-sumers accounting for only 38 percent ofgross domestic product, far below the levelsof many developing and developed coun-tries.

Chinese leaders are working to shift to-ward a more domestically directed econ-omy. they want households to spend moreand save much less than the current rate ofalmost 30 percent. one of the reasons thatsavings play such a big role is the high valueConfucian society puts on providing forone’s family. the Chinese also save to payfor education for their children and to coverhealth care and retirement costs becausethere is no equivalent of Medicare and so-cial security.

In 2010, the Chinese governmentpromised basic health care for all by 2020.that’s eight years from now, and basic careremains pretty basic. In some rural hospi-tals, a practical nurse is the most highlytrained medical practitioner.

HigHer Wages

China has also increased minimum wages20 percent to 30 percent in the last year toenhance consumer incomes and purchas-ing power. Yet higher pay, notably for fac-tory workers producing goods for foreigncompanies, is driving low-skilled manufac-turing jobs to cheaper venues such as Viet-nam, Bangladesh and Pakistan.

Furthermore, Western companies areincreasingly resisting the requirement thatthey transfer technical expertise to Chinesepartners as the price of setting up produc-

tion facilities in China. there is a wide-spread belief that much of the success ofChinese manufacturers is due to such vol-untary technology transfers or outrighttheft of intellectual property.

China recently reduced its target forreal GDP annual growth to 7.5 percent from8 percent. that target is probably too highas China’s one-child policy leads to a pop-ulation decline, especially among newlabor-force entrants. the number of 15- to24-year-olds is already dropping and thisgroup is projected to account for 150 mil-lion people in 2030, compared with250 million in 1990. As a result,China’s labor force between theages of 15 and 65 is expectedto peak in 2014.

China’s ample laborhas increased GDPgrowth by an esti-mated 1.8 percentagepoints annuallysince the 1970s, butthe contraction willcut into growth by0.7 percentagepoint by 2030. Atthe same time,better conditionsin rural areas havereduced the avail-ability of cheaplabor in coastalcities.

By contrast, Indiahas had no effectiveconstraints on populationgrowth. China still has theadvantage — with 1.34 billionpeople last year, compared withIndia’s 1.24 billion — though not fortoo much longer. Furthermore, the agedistribution of India’s population is betterbecause of China’s one-child policy, whichis now being reconsidered in view of itsnegative consequences for the country’slong-term labor force and economicgrowth. this means that the dependencyratio, the proportion of children and seniorcitizens to working-age people, is expectedto continue falling in India in comingdecades and to increase in China.

Younger PoPulation

Younger people, of course, tend to be moregeographically mobile, flexible in terms ofoccupation and creative. But these advan-tages only translate into greater productiv-ity and economic growth if these workershave the right education and training aswell as job opportunities.

several centuries of British colo-

n i a lrule left India with a vigorousdemocracy and a parliamentary form ofgovernment. As in the U.s., these kinds ofinstitutions are very well adapted to run-ning a large, religiously diverse countrywhere the central government is con-strained by increasingly powerful statesand weak coalition governments. China,

however, remains centrally controlled, withthe Communist Mao Dynasty, as I’vedubbed it, simply replacing the dynasties ofold.

the British also left India with a rail-way system that enabled the relatively easymovement of people and goods in that vastcountry. By contrast, China doesn’t grantresident status to farmers who move tourban areas in search of work.

And, of course, the British gave Indiathe English language — very useful intoday’s world and a unifying force in acountry with hundreds of languages and

dialects. India also inherited a legal sys-tem that is very different from the

Communist Party-dominatedcourts in China, which feature

show trials and foregone con-victions, as demonstrated by

the recent trial and convic-tion of Gu Kailai, the wifeof the disgraced partyleader Bo Xilai.

India is also hometo a number of large,sophisticated compa-nies, such as tataGroup, that can com-pete globally. China,meanwhile, is burdenedwith government-con-trolled banks and other

hugely inefficient state-owned enterprises that

still produce a significantshare of GDP and employ a

quarter of the workforce.Indians have a natural bent

toward technology, as was pointedout to me by the U.s. ambassador to

India when I visited him in his New Delhioffice in 1986. the ability of India’s many en-gineers and scientists to communicate inEnglish is also a big help. Furthermore, thebooming information-technology sector re-lies more on new technologies such as satel-lite transmission than it does on India’sutilities and inadequate basic infrastructure.

englisH sPeakers

Us and European companies outsource

many back-office and even legal and med-ical services to India. outsourcing nowyields about $69 billion in annual revenue,accounting for a quarter of Indian exports.the lower wages in India and English-lan-guage skills of call-center employees offerbig advantages to this industry.

Another asset for India, as well asChina, is a rapidly growing middle class.PricewaterhouseCoopers LLP estimatesthat 470 million Indians, or 38 percent ofthe population, had annual incomes of be-tween $1,000 and $4,000 in 2010, enoughto permit some discretionary spending. thenumber of consumers with such ready cashis expected to jump to 570 million in adecade, with about $1 trillion in income.

the household-savings rate is high, al-most 30 percent. Even so, 82 percent of In-dian households had phones, usuallymobile, last year. of the 247 million Indianhouseholds, 77 percent owned televisions,and 42 percent had bicycles, motor scoot-ers or motorcycles, though only 10 percentpossessed a motor vehicle, according to the2011 census of India. Furthermore, muchof Indian household saving is invested ingold and the dowries of yet-to-be marrieddaughters.

Another strong point is that the Re-serve Bank of India is relatively independ-ent of government influence, while thePeople’s Bank of China is completely con-trolled by the state. During the recentregime change in China, the PBoC gover-nor, Zhou Xiaochuan, was dropped fromthe list of 205 members of the CommunistParty’s Central Committee and is appar-ently being forced into retirement. Politi-cians, not central bankers, call themonetary shots in China.

India has a vigorous and opinionatedfree press, compared with China’s state-controlled propaganda machine. Internetuse in India is expanding, although it is stilltiny compared with the U.s. and even itsBRIC cohorts: Brazil, Russia and China.

A Gary shilling is president of A. Garyshilling & Co. and author of “the Age ofDeleveraging: Investment strategies for aDecade of slow Growth and Deflation.” theopinions expressed are his own. this is thefirst in a five-part series. Courtesy BloomBerg

Financial reform’s breakthrough year

Why India will displace China as global growth engine

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02Business

rObert l bOrOSAGe

2012 was the first class-warfare election ofour new Gilded Age. the first since themiddle class has come to understand, in thewords of new senator-elect Elizabeth War-ren (D-Mass.), that the “rules are riggedagainst it.” Business-as-usual may nolonger be acceptable.

But Washington didn’t get the memo.Even as ballots were still being counted inPalm Beach, Florida, the two partieslurched into the fierce debate over the fiscalcliff, the noxious brew of auto-matic spending cuts and ex-piring tax cuts that wouldpoison the recovery.the debate, a dismalsequel to the 2011debt ceiling melo-drama, focuses ondeficits not jobs.once more, Repub-licans are threat-ening to blow upthe recovery un-less Democratsmake otherwise un-acceptable conces-sions. once more,President Barack obamalooks for a “grand bar-gain,” seeking bipartisansupport for terms di-vorced from opin-ion outside

the beltway. once more, what scott Galupoat the American Conservative called the“clown show” of the House Republican cau-cus blows itself up.

Republicans are the most cluelessabout this new reality. the election’s oneclear mandate, confirmed in polls eversince, was for obama’s oft-repeated pledgeto let the Bush tax cuts expire on thoseearning more than $250,000. Yet, HouseRepublicans stood staunch in defense ofthe very rich – refusing to pass their ownspeaker’s bill to extend the tax breaks on

everyone except millionaires.this came after House speakerJohn Boehner (R-ohio) spent

weeks insisting that Republi-cans would allow the Bushtax breaks to expire on therichest Americans only ifthe president agrees to cut

Medicare, Medicaid andsocial security, the corepillars of family security.

When the presidentcame perilously close togiving him yes for an an-

swer, Boehner broke offtalks to get House Republi-cans to vote on his “Plan B”

extension of all tax cuts for in-come under $1 million a year.

But, with near Keystone Cop in-competence, House Republicansthen blew up their own speaker’s

plan. they recoiled at the hor-ror of raising taxes on

millionaires –

though they could also eliminate the auto-matic spending cuts for the Pentagon,while doubling them on education, foodsafety and other domestic programs.stunned, Boehner sent Congress home forChristmas, telling the media “God onlyknows” what will happen next.

obama’s popularity has soared as Re-publicans have flailed about.

Yet obama continues to seek a“grand bargain.” His last offer toBoehner would cut social security, veter-ans’ benefits and other government ben-efits over time with the lower inflationrate adjustment – the “chained CPI” – inexchange for ending tax breaks for thoseearning more than $400,000. House Mi-nority leader Nancy Pelosi (D-Calif.) saidshe could deliver House Democrats tosupport that compromise.

Nothing more clearly exposes thestark gulf between conventional wisdominside the Beltway and the opinions ofmost Americans. Americans of all stripesare increasingly aware that they havebeen getting the shaft, while the bigbanks, corporations and money have beenpocketing the gold. Large majorities be-lieve their legislators are essentially cor-rupt – more responsive to their donorsthan their voters.

that’s why poll after poll shows thatbroad majorities of Americans – includingmajorities of Republicans – support raisingtaxes on the wealthy. overwhelming ma-jorities – including most Republicans –want Medicare, Medicaid and social secu-rity protected, not cut.

In an election night poll sponsored bythe Campaign for America’s Future, voterswere asked what they would find accept-able in a deal to cut deficits. sixty-two per-cent said cutting social security over timewas unacceptable. Even more, 72 percent,opposed cutting discretionary spending,like “education, child nutrition, workertraining and disease control.” Almost four-fifths, 79 percent, opposed forcing seniorsto pay more for Medicare.

As for raising taxes on the top 2 per-cent, more than two-thirds, 70 percent –

including a majority of Republicans –found it acceptable. Far more, 89percent, supported saving Medicarecosts by negotiating lower drug

prices from drug companies. sev-enty-two percent supported

reducing military spendingby ending the war in

Afghanistan. More thantwo-thirds supported aminimum tax on corpo-rate profits reportedoverseas. Americans sup-port compromise. Cour-

tesy reuters

Kim Jong-un as culticon? The joke’s on you,capitalist comrades!

Alex hObAn

Kim Jong-un has the best job in the whole world, right? He’s bequeathed hispeople dolphinariums filled with backflipping sea-life and high-adrenalineroller-coasters that rival Alton towers. He’s spruced up his capital city withflashy times square-style billboards and built its burgeoning hipstercontingent a massive skatepark. He smokes whilst casually launching big-boyrockets. He has a beautiful fashionista wife and a box-top haircut to rival theFresh Prince of Bel Air. LoL. one helluva guy. that, at any rate, seems to beincreasingly the image of North Korea’s supreme leader – a view that tends tooverlook the fact that the nation he is supposed to look after suffers from severemalnutrition and chronic corruption. When spoof news website, the onion,ran an article claiming the young ‘un was the “sexiest Man Alive”, the affectionfor the socialist regime’s new dynastic ruler seemed sincere enough thatChinese state media mistakenly re-reported it as truth. this week timemagazine decided to cast off 5.6m votes for the supreme Leader Kim as Personof the Year, which North Korean state Media nevertheless reported as anunbridled victory. Admittedly, the 5.6m votes did turn out to be erroneoustroll-casts by the tiresome netizens of 4Chan, but still – what if they’re justsaying what we wish we weren’t all thinking? What if our tongue-in-cheekadoration for Kim is an expression of our own frustrations with another year ofdirectionless recession, austerity, uncertain leadership and a deep moralambiguity in the ever-stuttering procession of western zombie capitalism?Meanwhile, behind the surreal cartoon version of North Korea, the west’srelationship is changing in a more fundamental way. When luxury Germanhoteliers Kempinsiki announced it would be opening North Korea’s muchmaligned “Hotel of Doom”, CEo Reto Wittwertastefully predicted the deal would become a“money printing machine”. It cameas part of a wave of luxury re-developments in the capital city

Pyongyang, including itsnew showpieceMansudae area.

Courtesy the guardian

nOuriel rOubini

the risks facing the euro zone have been re-duced since the summer, when a Greek exitlooked imminent and borrowing costs forspain and Italy reached new and unsustain-able heights. But, while financial strains havesince eased, economic conditions on the eurozone’s periphery remain shaky.

several factors account for the reductionin risks. For starters, the European CentralBank’s (ECB) “outright monetary transac-tions” programme has been incredibly effec-tive: interest-rate spreads for spain and Italyhave fallen by about 250 basis points, evenbefore a single euro has been spent to pur-chase government bonds. the introduction ofthe European stability Mechanism (EsM),which provides another €500 billion to beused to backstop banks and sovereigns, hasalso helped, as has European leaders’ recog-nition that a monetary union alone is unsta-ble and incomplete, requiring deeperbanking, fiscal, economic, and political inte-gration.

But, perhaps most important, Germany’sattitude towards the euro zone in general, andGreece in particular, has changed. Germanofficials now understand that, given extensivetrade and financial links, a disorderly eurozone hurts not just the periphery, but also thecore. they have stopped making public state-

ments about a possible Greek exit, and justsupported a third bailout package for thecountry. As long as spain and Italy remainvulnerable, a Greek blowup could spark se-vere contagion before Germany’s electionnext year, jeopardizing chancellor AngelaMerkel’s chances of winning another term. soGermany will continue to finance Greece forthe time being.

Nonetheless, the euro zone peripheryshows little sign of recovery: the gross domes-tic product (GDP) continues to shrink, owingto ongoing fiscal austerity, the euro’s exces-sive strength, a severe credit crunch under-pinned by banks’ shortage of capital, anddepressed business and consumer confi-dence. Moreover, recession on the peripheryis now spreading to the euro zone core, withFrench output contracting and even Ger-many stalling as growth in its two main ex-port markets is either falling (the rest of theeuro zone) or slowing (China and elsewherein Asia). Moreover, balkanization of eco-nomic activity, banking systems, and public-debt markets continues, as foreign investorsflee the euro zone periphery and seek safetyin the core. Private and public debt levels arehigh and possibly unsustainable. After all, theloss of competitiveness that led to large exter-nal deficits remains largely unaddressed,while adverse demographic trends, weak pro-ductivity gains, and slow implementation of

structural reforms depress potential growth.to be sure, there has been some progress

in the euro zone periphery in the last fewyears: fiscal deficits have been reduced, andsome countries are now running primarybudget surpluses (the fiscal balance excludinginterest payments). Likewise, competitive-ness losses have been partly reversed aswages have lagged behind productivitygrowth, thus reducing unit labour costs, andsome structural reforms are ongoing. But, inthe short run, austerity, lower wages, and re-forms are recessionary, while the adjustmentprocess in the euro zone has been asymmetricand recessionary/deflationary.

Meanwhile, the monetary union re-mains an unstable disequilibrium: eitherthe euro zone moves towards fuller integra-tion (capped by political union to providedemocratic legitimacy to the loss of nationalsovereignty on banking, fiscal, and economicaffairs), or it will undergo dis-integration,fragmentation, and eventual breakup. And,while European Union leaders have issuedproposals for a banking and fiscal union, nowGermany is pushing back.

German leaders fear that the risk-sharingelements of deeper integration (EsM’s recap-italization of banks, a common resolutionfund for insolvent banks, euro zone-wide de-posit insurance, greater EU fiscal authority,and debt mutualization) imply a politically

unacceptable transfer union whereby Ger-many and the core unilaterally and perma-nently subsidize the periphery. Germany thusbelieves that the periphery’s problems are notthe result of the absence of a banking or fiscalunion; rather, on the German view, large fis-cal deficits and debt reflect low potentialgrowth and loss of competitiveness due to thelack of structural reforms.

of course, Germany fails to recognizethat successful monetary unionslike the Us have a fullbanking

unionw i t hsignificantrisk-sharingelements, and afiscal unionwhereby idiosyn-cratic shocks to spe-cific states’ outputare absorbed bythe federal

budget. the Us is also a large transfer union,in which richer states permanently subsidizethe poorer ones.

At the same time, while proposals for abanking, fiscal, and political union are beingmooted, there is little discussion of how to re-store growth in the short run. Europeans arewilling to tighten their belts, but they need tosee a light at the end of the tunnel in the formof income and job growth. Courtesy livemint

The euro zone’s delayed reckoningg While financial strains have eased, economic conditions on the euro zone’s periphery remain shaky

Class war in the new Gilded aGe

g Laughing at North Korea’s absurdities is a

decades-old pastime, but the west now has

reason to be more nervous than amused

Monday, 24 December, 2012

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