Greece—The International Moral Hazard Fund (aka IMF) to the Rescue
Peter T Treadway also serves as Chief Economist, CT RISKS, Hong Kong.


March 29, 2010


As this was written, the IMF had been invited in to join the EU in providing aid to Greece on a standby basis in the Greek crisis. The IMF of course has never met a country that it wasn’t ready to bail out. And now the EU is setting a bailout precedent.

I would make the following comments:

First, IMF bailouts sometimes ultimately don’t prevent defaults. Witness Russia 1998 or Argentina 2001.

Second, any set of conditions for aid that imposes the requirement of higher taxes on Greece would be counterproductive. Simple Keynesian economics holds that raising taxes or cutting government expenditures amounts to the same thing. Wrong. Raising taxes to pay for bloated and unproductive government expenditures and entitlements is a huge negative for productivity and economic growth. Only government spending cuts make any economic sense. One reads endless tut tutting about how tax evasion is a national pastime in Greece. I would ask why would productive citizens in the private sector willingly submit to a confiscation of their incomes to finance a bloated public sector? What’s in it for them? Macroeconomic policies that ignore microeconomics are recipes for disaster. The Greek government has already announced a package of tax increases and spending cuts. This may not be enough for the markets which will be called upon to refinance some 20 billion euros of Greek debt in the coming months. Anyway we’ll see if this package will really be put into place. One observer put this package in the same category as an alcoholic’s New Year’s resolution to give up the booze. No doubt the tax increases will go through. Probably most of the government spending cuts will not. Bad news for Greece.

Third, people underestimate the huge value added that the euro represents. The euro isn’t going away. Europe and the world need the euro. A regression to financial balkanization that a return to national currencies represents would be an unthinkable step backwards. The Greek crisis is overrated. The US as a monetary union survived after eight states and one territory defaulted in 1841-2. The long run attractiveness of the euro depends on whether Europe opts for economic growth like the US in the nineteenth century. Unfortunately, a bailout for Greece which raises taxes to pay for a bloated state sector is not a recipe for economic growth. A default and a forced reduction in the Greek state sector would have been better for the euro.

China’s Trade Surpluses Should Disappear and China Will Have Inflation

Sooner or later China’s huge trade surpluses will disappear because rising inflation in China will reduce the competitiveness of its exports and because economics dictates that the US reduce its own trade deficit. China has had three choices to deal with its mounting trade and reserve surpluses: 1) revalue in nominal terms, 2) maintain the value of the renminbi in nominal terms, sterilize capital inflows and let foreign reserves build up to levels that were politically and economically unmanageable and 3) revalue in real terms via inflation while holding the nominal exchange rate against the dollar constant. It first chose nominal revaluation when from 2005 to 2008 it allowed the renminbi to move gradually from 8.3 to 6.2 per dollar. Concurrently it followed option 2 which is not a viable strategy in the long run. But over the last year with its stimulus program it has chosen option 3.

Senator Schumer take note. The renminbi is being revalued in real terms via inflation. The inflation could have been avoided by allowing the renminbi to float upward but that’s not the choice China has made. My own view is China made a bad choice.

Various explanations have been given for China’s massive trade surpluses and build up of foreign exchange reserves. My answer – and the answer of the majority of analysts around the world – is that the renminbi has been undervalued. Markets if allowed to operate do not remain in perpetual disequilibrium. Unless interfered with, markets clear, imbalances are removed. But if markets continuously interfered with on an international level, untenable economic imbalances emerge and political responses are provoked in countries that feel disadvantaged by these policies.

That is where China is today. It faces rising inflation and rising US anger at what seem to be “beggar thy neighbor” policies by China. This is a high risk strategy. Inflation at home, political problems abroad. Inflation is a poison everywhere. And once the politicians in America get their hands on a problem, things inevitably go downhill. Parenthetically, economists in America who are recommending sanctions of various sorts against China should think twice. Their solution may be worse than the problem especially if, thanks to Chinese inflation, the problem is about to diminish.

Inflation in China is hard to measure. Thus far according to published indexes there has been a modest resurgence as the February CPI and PPI are up yoy 2.7% and 5.4% respectively. But with China statistics cannot always be relied upon. Anyone visiting China hears stories of galloping residential real estate inflation. And anecdotal conversations with importers reveal that once unbeatable “China price” has lost a good deal of its competitive advantage.

Actually the world is about to find out that figuring out what is happening in China is not an easy task. Trade data and foreign reserve data may be fairly reliable. As are exchange rates. Those are the key indicators on the currency. But things get murkier after that especially when the numbers involved have domestic political sensitivity. Across the globe we hear ever louder forecasts of a boom, then a bust coming for China. Certainly the 32% growth in bank loans last year is a red flag, especially since it has now become known that a good deal of these loans have gone to special entities called UDICs set up by local governments. Anecdotal stories of massive overcapacity in commercial and residential real estate, basic industries and even airports continue to make the rounds. People are starting to notice that the new nationwide high speed railroads are bad news for the airlines.

The bulls on China counter argue that with its huge population and rapid growth, China, like a fast growing two year old, will rapidly grow into its excess capacity. 1.3 billion Chinese, most of who work hard and sincerely want to be rich, are a powerful force that will overwhelm bubble effects. The non-performing loans that are bound to come from the excesses in lending in 2009 will be bailed out by the government in due time. Thus Chinese investors – unlike their Western counterparts — are perfectly willing to hold empty apartments which, like gold, serve as a store of value. High vacancy rates, no problem. Not to worry — China is different.

The Japanese used to be different too. Until their bubble finally burst. Except nobody had the timing on that right.

China is a country that restricts information flows, has notoriously unreliable statistics and operates in a language most foreign analysts can neither read nor speak. The bubble could go on for years. Or it could end tomorrow. Nobody really knows. Going short China is a high risk trade even if ultimately correct. “The market can remain irrational longer than you can remain solvent,” John Maynard Keynes once said.

Zaijian (Goodbye) Google

No doubt many readers will have an entirely different view from the one I am about to express. But in my opinion, by its decision to (effectively) leave China, Google did a disservice to China, the United States and its own shareholders. Google has given up the world’s largest internet market. No doubt it will make lots of money in other places. It’s a big world. Google has put knowledge just a click away and is one of the world’s revolutionary institutions. Still, when that day arrives when China is “pure enough” to meet Google’s standards, Google will have lost its position in China and not be able to get it back.

This is not an apologia in behalf of Chinese censorship of its internet. China has a real problem with its enthusiastic embrace of new information technologies and its simultaneous desire to control content flowing through these new technologies. Anyone who has landed in one of China’s brand new airports, has been whisked on a six lane highway to a five star hotel and then mysteriously couldn’t get his or her computer to connect to Western and Hong Kong websites can appreciate this contradiction. Information needs to be free in advanced information societies. It’s clear China is not one of those societies…yet. It makes an interesting contrast with a freer – but more backward – India.

But an imperfect internet is better than no internet at all. Google had to know what it was getting into when it arrived in China. China should not always be compared to the perfect world but rather to the world it only recently emerged from. The White Lotus Rebellion (1796-1804), two Opium Wars (1840, 1860), the Taiping Rebellion(1851-1864), the Sino-Japanese War(1895), the Boxer Rebellion(1900), the fall of the Qing Dynasty (1911), the Japanese invasion and WW II (1937-1945), the Chinese Civil War (ending 1949), the Great Leap Forward (1958), the Cultural Revolution (1966-1978)—the history of China over the last two hundred years has been one of bloody internal revolts, lost wars and disruptive social experiments. All this in a country that from its still influential Confucian past places great emphasis on social harmony and obedience to authority. Nobody knows what the average Chinese really thinks about restrictions on the internet since taking surveys on this question undoubtedly is not permitted. The older generation might have a different opinion than the younger. But my guess would be that most Chinese do not want to risk a return to the chaos of the recent past and perhaps reluctantly are willing to accept restrictions on the internet so long as prosperity and stability continue. And I also believe that the majority of Chinese – though clearly not all—will regard Google’s departure as another arrogant assertion of Western moral superiority.

Peter T Treadway also serves as Chief Economist, CT RISKS, Hong Kong

Peter T Treadway, PhD
Historical Analytics LLC
305 761 4718
852 94091186
March 28, 2010


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