Big Spender Meets Big Saver

By Adrian Ineichen

The Great Contrast
Recently, President Obama travelled to Asia and visited Japan, the APEC summit in Singapore and went to China and Korea. The contrasts were stark, particularly in China: here comes the representative of the world’s most powerful democracy whose people save on average 3% of their disposable income (at some point in recent years, this figure has been negative) to the world’s largest nation whose people save about 20-25% of disposable income which lifts the gross domestic savings rate above the 50% mark. The big saver has (too?) much invested into the debt of the big spender and fears now that the latter’s bad economic conditions (unemployment above 10%, perennial current account and government deficits, etc.) may render the saver’s US assets that are estimated to top US$ 1.5 trillion less valuable (e.g. through potential inflation in the future or a depreciating dollar).

It is remarkable when the joint China-US statement issued on November 17 during Obama’s China stay says this: “United States will take measures to increase national saving as a share of GDP and promote sustainable non-inflationary growth. To achieve this, the United States is committed to returning the federal budget deficit to a sustainable path and pursuing measures to encourage private saving.”

How often have you seen a country pledging to be financially more responsible in a bilateral communiqué? It is not remarkable  that foreign powers prod the US to act, which may seem embarrassing enough, but it is remarkable because they are right and we should act, but have failed to do so for decades. Germany’s finance minister Schäuble warned last Friday against a looming fresh asset price bubble due to low US interest rates – which are expected to stay low for some time to keep liquidity and credit available – and provides the latest addition to the global concerns about US finances.

It Takes Two to Tango
The big spender (aka big debtor) knows that he has to adjust (boosting domestic savings and exports), but faces an uphill battle, given the urgent task to resolve the current crisis and get financial (and other) regulations right, on the domestic front.

Boosting saving is not easy in a consumption culture, and various policy tools have already proven to be ineffective. C. Fred Bergsten proposes three options worth considering. First, the US could switch from taxing income to taxing consumption which would put pressure on consumption. This idea may also be fruitful on its own as textbook economics tells us that consumption-based taxation has less distortionary effects than income-based taxes. Further, this would allow to clean up the US tax code (if Congress really seizes this once-in-a-lifetime chance) and could kill the current inefficient and administratively onerous retail sales taxes by a value-added taxation system.

Second, the introduction of mandatory savings schemes, let’s say of one or two percent on an individual’s income which could be retained in a separate account and used after retirement as a complement to the social security benefits. Third, medical and social security costs are contained e.g. by a comprehensive health care reform (recall, one of the original ideas of the current health care reform was to contain costs) and by a social security reform that may include the increase of the retirement age (a path that Germany has chosen and many Western European countries are likely to adopt in the future as well, given the demographics) and the reform of contribution and benefit formulas.

At the same time, an effective correction of imbalances requires the big debtor to coordinate with its biggest banker/creditor (i.e. the big saver) who himself has some daunting tasks ahead.

To get back on a sustainable growth path, the mainstream opinion suggests that China should boost domestic consumption and reduce its savings rate. At least three policy options could help. First, an increased redistribution could give high corporate profits away to poor Chinese people who may then spend more. At the same time China should reduce excess capacity and over-investment in certain industries (such as cement, steel, coal etc.). This is the Jonathan Anderson story which emphasizes that most of the savings are made by corporations and thus a resolution of the imbalance would require to start with changing the current industrial policy. It is noteworthy that Chinese investments this year have risen (pushed by stimulus). Second, improving the social safety nets, revamping education facilities and access and expanding public health care can increase spending directly, and may reduce the need for people to save as they can expect to have safer income sources when they are old and to be able to cope with health issues.

Third, the big saver allows for external adjustments to take place. In general, a revalued exchange rate would make Chinese exports less competitive and would thus squeeze corporate profits. While some call for a direct renminbi appreciation, others say that this move may not do much to rebalance the global economy (and may not have a large impact on the US current account deficit). It is likely that both sides miss the point. The key is that the current unofficial peg of the renminbi to the dollar (since summer 2008, after an appreciation path since July 2005) is not sustainable. It leads to foreign exchange surplus whose reinvestment has led to high risks and low returns, is a potential source for domestic Chinese inflation (which may arise in the coming years), and it attracts hot money which increasingly finds its way around China’s capital controls.

As China’s role in the global economy rises, the role of its currency is likely to grow too. To avoid adjustment shockwaves, a pragmatic approach could entail the speeding up of the gradual internationalization of the Renminbi, e.g. by expanding trade settlement or the institutional investor programs (QDII and QFII) while easing regulatory burden on cross-border capital flows. It will be interesting to see how the Chinese nomenklatura adjusts its policies when exports start to grow again and global outlooks further improve in 2010.

Nice to read:
Anderson, J. (2009. “The Myth of Chinese Savings”, Far Eastern Economic Review 172(9; Nov 2009), pp. 24-30.

Bergsten, C. F. (2009). “The Dollar and the Deficit”, Foreign Affairs 88(6; Nov/Dec 2009).

U.S.-China Joint Statement, November 2009

Germany warns US on market bubbles

Chinese Banks and the Minsheng Case

By Adrian Ineichen

Economic Growth
While many major countries have suffered economic contraction or stagnation in 2009, China is expected to grow by about 8.2% in 2009. On the one hand, a massive stimulus package of approximately 4 trillion renminbi (RMB; about US$ 585bn) seems to have supported growth. Fiscal expansion has boosted infrastructure spending on airports, railways, bridges, environmental infrastructure and low-cost housing. This spending will contribute to a record budget deficit of 3.8% in 2009 (comparably, the US federal budget deficit for 2009 up to date is at about US$ 1.4tr, which is more than 66% of projected revenues, according to CBO estimates as of November).

On the other hand, Chinese bank lending has contributed to support economic activity. For the period January to October, total bank lending has accumulated to RMB 8.92tr in 2009 while the same period in 2008 saw lending at RMB 3.66tr – an increase by the factor 2.43. Overall lending for the whole year 2009 may well hit the 9.5tr level which would approximately equal the US federal deficit in dollar terms.

Chinese Banking
Such gigantic figures raise the questions about how sustainable and well-targeted such lending is. Recent steps point towards a tightening of the lending boom. The China Banking Regulatory Commission (CBRC) has warned about the build-up of risks in the banking sector. Concerns have arisen that some of the new money is flowing into equity markets and real estate speculation.

So far, the ratio of non-performing loans (NPL) across the banking sector is low at 1.7%. The state-owned banks, particularly the top-five which have been used in the past by the government to direct credit, have relatively higher figures than some privately owned banks. Chinese banks may need to raise more capital in order to strengthen their balance sheets. Further, the People’s Bank of China is expected to tighten monetary policy and, among others, raise reserve requirements.

It will be interesting to watch how policies will balance between growth targets (and thus new lending and investments) and financial stability (and thus maintaining capital adequacy and prudent risk management). In any case, historical experience suggests that if NPLs are rising again, this may be hidden for some time and in the end the government may step in to clean up (as in the early 2000s). Such a wait-and-see approach is not only very costly, but also lengthy and it takes years to be effective (for example as late as August 2008, the Economist Intelligence Unit estimated the NPL ratio of one of the top-five state-owned Chinese banks to be at more than 23%). Damage to the banking sector could be long-lasting.

A Brighter Spot?
One of the brighter dots on the Chinese banking scene is the China Minsheng Banking Corporation (CMBC). Minsheng’s NPL with less than 1% is about half of the average. Last week, it raised US$ 3.86bn by listing on the HK stock exchange. With this step, CMBC’s tier 1 capital ratio increases to 8.65% (from 5.90%). While the Basel standard for tier 1 is 4%, many Western banks have strengthened their sometimes heavily damaged balance sheets since the current crisis broke out; the Swiss bank Credit Suisse has currently a tier 1 capital ratio of 16.4%, while Citi’s it at 12.7% and the British HSBC has 10.3%.

Even though the share offer appears to have been modestly priced and the retail part was 154 times oversubscribed, the shares took a hit on their first trading day in Hong Kong. This could hint at some market uncertainty about the soundness of Chinese banks, although CMBC looks comparably well-off. How will the market react when other Chinese banks raise their capital? Some others say Minsheng’s profitability is relatively weak which could explain the less-than-enthusiastic response to the listing.

Minsheng’s bid to take over a Californian bank, the United Commercial Bank (UCB) was deplorably thwarted in November 2009 by FDIC’s intervention to save the bankrupt UCB. The Federal Reserve could not grant approval to the Minsheng take-over of UCB as its home regulator, the CBRC, does not yet meet American standards for “consolidated supervision.” While such requirements may seem plausible (if they are too weak, a worst case scenario would be that many badly regulated and managed foreign banks could own American banks and engage in excessive risk-taking and undermine US financial stability), the Minsheng case is unfortunate as it involved one of the better Chinese banks willing to avoid the bankruptcy of a US bank. The FDIC intervention comes at an aggregated cost of US$ 1.4tr plus 300m lost TARP funds. Minsheng loses its 10% stake it had already in UCB.

It appears that the FDIC and the Fed should improve their coordination among themselves and with foreign regulators to avoid such cases which cause anger abroad and at home and lead to higher taxpayer’s costs. While prudential regulations are important, they should not spur domestic protectionism. Entry of foreign financial institutions in the US, but also in China and elsewhere can spur competition and market discipline and thus should be welcomed. I hope that regulators can work together to reduce barriers for foreign entry, streamline regulations and make them more transparent. A bi- (or: multi-?) lateral investment treaty would be a step in the right direction.

Suggested Links

About Minsheng Bank’s Hong Kong Listing:

The Economist about Minsheng:

UCB Failure and the Non-take-over:

Recent figure on the US budget deficit:

About Chinese lending:

EIU Country Report China December 2009